Market Commentary – 18th October 2018
Keep calm, and carry on as corrections are inevitable
So far, October has been a very interesting month and markets have without a doubt been jumpy. Despite this, I think it’s also fair to say that it’s been a very anticipated time where we have been waiting on a looming market correction. Since the February correction, we have been closely watching and waiting for this one, based on the precariousness of the markets. Markets have been unsettled with rising volatility and concerns over this extended bull run, but again we have to stress that bull markets don’t die of old age and foresee this bull to continue to run along!
Across the board, we have not just seen the equity markets fall, but also all other markets struggling to find ground with the main source being the dynamics and economics in the US. US treasury yields have risen above the psychological point in response to the strength of the economy and rising inflation. Until recently, markets had been worried about a flattening US yield curve and whether it was signalling a recession but, more recently, they have been worrying about the move higher in US Treasury yields. The constant in both scenarios is the rising short end, driven by the US Federal Reserve’s clearly signposted tightening cycle. With inflation, the US continues to raise interest rates to normalise monetary policy, and the Federal Reserve will most probably continue to hike based on the strong economy. This does pose the question if this is the right thing to do as Trump has been blaming the Fed for increasing rates too quick, when according to theory the Fed needs to as inflation heightens.
In terms of the real economy, for some time it has been dominated by strong corporate earnings and economic growth, though there are inflationary pressures building. This broadly positive backdrop is currently getting tested, as we move through the third quarter corporate earnings season, especially the question of whether wage growth is hurting margins and whether an extended trade war is impacting activity. So, trade war fears linger on, as do concerns about how effective Chinese policy will be. On a whole I think its fair to suggest that the global picture is strong, however is worrying investors and overall sentiment as to how strong it continues to be. Like we have stated in our last commentary, if we just focus on the data and the economics, we shouldn’t really see anything bringing the markets down, but with worrying concerns, could we continue to see underlying weakness? The political risks and concerns over the trade wars, rising energy prices, increasing interest rates and the US Dollar strengthening continue to weigh the markets down. Despite investors’ sentiment weighing down on the markets, another reason why the fall we saw in the markets was based on computer automatic trading and based on how nervous investors are over this extended bull run, the margins of the limit orders set, have reduced in size and tolerance, and therefore has also been the catalyst over the correction we saw.
Are we worried?
Our job is to be worried and to closely watch the markets and the factors that impact the markets to deliver on the agreed returns on our client’s portfolios. However, it is imperative to note that we must also stay calm and focus on the economics and sometimes accept that the markets do fall which sets us back, but we must avoid having emotional ties and responses to the markets and their developments. Our strong conviction in holding specific funds, have they been, directional investments or multi asset investments shows that we are well positioned in the upper end of the markets and aim to choose the best markets to invest in over this precarious market cycle.
Another part of me is very optimistic over the types of assets we hold and the fund managers we employ, and as we speak to them, it’s very interesting to note that they haven’t really changed much of the types of assets they hold and the margins of equity they hold. Having adopted a more cautious multi asset mandate, we are able to protect on the downside and remain invested but capture the upside when equity markets climb. The fund managers in this space do have the ability to rotate the assets they hold and are able to hold high conviction assets, if they feel the need too. Globally, our fund managers are still considering liquidity conditions to be supportive, notwithstanding recent rate rises, and are certainly far from restrictive. Equities are not cheap, but they still have some room to grow further as corporations are continuing to do well, by strong consumer demand and underling confidence. Tech stock are without a doubt the main extreme when it comes to overvaluation, however equity valuations are not far out of line with long term averages.
One of the main questions we are now asking ourselves, and so are other investors is whether equities can absorb higher bond yields (if they continue to go up) and, if they can, which part of the market leads? If any moves higher in bond yields are gradual, rather than disorderly, it is much more likely that equities can move forward. In terms of which part of the market leads, this is currently unclear to us and we have left this to the multi asset fund managers to decide, as sector rotation has been evident but has not left consistent winners or losers. It could end up being less about sectors and more about stock characteristics, for example whether they are less indebted or whether they have some ‘inflation-proofing’.
Our general stance is caution, with recent market developments reducing the complacency of the last few months. After speaking to the fund managers, our assessment of the fundamentals does not reveal a particular worrisome picture, but we do remain vigilant for signs over extreme valuations, the extended bull run and economic conditions heating up too much.
Are the markets edging back up?
Corporate earnings season has begun and has been the main catalyst we are seeing towards pushing the markets back up from the lows we saw, however the fall was further exacerbated over the fears that earnings will find it hard to stay strong as wage pressures impact margins. As we continue through the earnings season, we expect the pickup to start feeding through into the portfolios as there is definitely a lag.
If we look at the markets, yes, we had a sell off, however buyers have now returned to the markets and this can be substantiated in the money flow index, which is one of our barometers we are closely looking at and the data can be found in the attached document. This paints the picture over the sell off, and the quick positions back in soon after based on depreciated valuations. Volumes remain strong and investors are locking back into the next mini- corporate earning cycle. The core fundamentals which the markets lay on remain strong, and the recent pullbacks we have been seeing are just part of the economic cycle and the cycle of investors sentiment, which is largely compressed when we compare it to the boom/bust cycle. Yes, these corrections are painful, and they set a picture of a volatile market, but the fact that the market has scope to head back towards the peak, just shows that we shouldn’t be worried about not being invested, yet!
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track down on a whole, however they are starting to pick back up as we get Q4 corporate earnings. We may continue to see tech stocks pick the markets up further.
Despite the correction we have seen, we remain invested as we have a strong multi asset mandate. Our investment positioning and strategy is derived from a fundamental believe of diversification and considering Modern Portfolio Theory, which is at the heart of OBI. Our multi asset strategies are well diversified through asset classes, geographical region, sector, investment styles and underlying holding.
Our role is to stay calm in the face of market setbacks and avoid the emotional response to market developments. We believe that the investment environment has not been altered by the recent drop in equity markets and rising volatility. We have highlighted in our market commentaries that volatility is to be expected as markets digest higher rates and rising inflation. The fact that we like the data and focus on the data shows that the fundamentals is why we are not worried. Moving on from here, we expect our strategies to deliver on their outcomes which is again being supported by the strong corporate sector and solid, but moderating economic growth.
The reason why we didn’t publish the market commentary yesterday was purely for the model portfolios to truly reflect the close price on Tuesday following the large gains in the stock markets the US finished trading at 9pm (US time). The fund price isn’t locked in, until 12pm the next day, and therefore reflected on the portfolios until Thursday.
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
Today is the BBC’s birthday! After two years of government and military control over a new innovation, radio broadcasting, the British public wants entertainment over their airwaves, and following hundreds of license requests and thousands of petition signatures, the British Broadcasting Company, or BBC, is founded.
As always have a wonderful week and stay safe.