Commentary on October 2018
After a relatively calm September, the financial markets were hit by October storms. At the month-end, the main stock-markets had fallen by 5-7%, in sterling terms, with Asian markets around 9% lower. The main emerging market index was 23% off its January high (technically described as entering a bear market). European banks and online retailer Amazon also picked up ‘bear market’ tags. So far, early November has seen shares rally by around 2%.
In early October, Chair of the US Federal Reserve Bank, Jerome Powell, warned that interest rates might need to be raised further than investors had expected, in order to prevent inflation from over-heating (subsequent minutes from the last meeting showed that a majority of members shared this view). The US 10-year bond yield ratcheted up to 3.25%, the highest in seven years; this was something that hadn’t been factored into market valuations, and triggered the fall in stock-markets. In an ironic twist, the US bond rallied, sending the yield 10 basis points lower, as investors sought the relative safety of government bonds.
Despite respecting the US central bank’s independence, President Trump failed to disguise his irritation, his comments ranging from the mild, “I don’t think we have to go that fast,” (in raising rates) to describing the Fed’ as “Having gone crazy,” and being the biggest threat to him and the US economy! And just for good measure, the Trump Twitter feed threatened another round of trade tariffs on China.
Europe witnessed further loss of momentum in the rate of growth, but a pick-up in inflation to 2.2%, the highest since 2012 and unambiguously above the mandated target range. But it was politics that dominated the headlines; the Italians officially submitted their budget proposals to the European Commission, who sent them home to do their maths homework properly and re-submit. Following poor state elections, Chancellor Merkel announced that she would step down as party leader in December, but would continue as (lame duck) Chancellor until her term finishes in 2021. Tedious Brexit discussions continued with little obvious sign of progress.
That stock-markets fell was of little surprise; it was the timing that was harder to predict. Equally, the subsequent rally could have been expected. The challenge comes in knowing where we go from here.
On the one hand, from a technical viewpoint, most stock-markets looked to have ‘tipped over’; such was the magnitude of the fall that there is room for further price increases whilst keeping the declining trend in place. On the other hand, economic growth is broadly positive, even more so in America where recent company earnings and workers’ pay surprised to the upside.
One further consideration, arguably the most important, is the level of leverage in the market; investments on borrowed money are less attractive as the cost of borrowing rises, and falling prices compound the agony, often leading to forced selling.
Fears of higher interest rates in the US, guidance by companies that higher costs and trade restrictions would impact on future earnings, and widespread political worries all contributed to October’s mini-crash. But economic, geo-political and valuation worries are not new; they were around during the emphatic bull market and will continue in one form or another. The major sea-change is that the global economy has switched from one of monetary stimulus (with central banks seen as ongoing buyers of assets) to monetary tightening; the lack of constant central bank support won’t preclude sharp rallies, but it will make the future direction of investment markets far less certain.
How are we currently positioned?
We used the sell-off to add a bit more risk across the portfolios, buying a multi-strategy fund that is currently focusing on value, a keen theme of ours.
We took advantage of the brief rally in fixed interest funds to further reduce our exposure to rising interest rates.
Although our holdings within absolute return funds proved disappointing, our other diversifiers, property and gold, showed minor gains.
We remain underweight fixed interest, preferring equities, property and alternative investments. Where we do hold fixed interest, we mostly use funds that have limited exposure to rising interest rates.