October has been a rough month for all global stock markets, with some decent downturns from 2018 highs.
This blog hopes to address the concerns currently weighing on market sentiment and to examine whether they are transitory and emotional, or more fundamental.
The biggest global concern depending on who you listen to, is either:
- US and China trade tariffs and the dangers to global trade and growth, or
- US interest rate rises, the withdrawal of QE liquidity in markets and the resultant dangers to global trade and growth
In addition, there are several other potential problems including:
- China growth slowing
- Brexit
- Italian debt levels
The recent downturn can be traced fairly directly to the moment the US Central Bank Chairman J Powell said in an interview, that US rates were still well below what he considered neutral.
In effect he was saying they had a fair way still to rise, which then caused US Treasury rates to spike 10% in a few days and the market started panicking.
What must be remembered is that historically what is seen as the ‘neutral’ interest rate, and a level that the US economy has dealt with perfectly well, is around 2% above inflation.
That’s to say that holding cash gives a 2% real rate of return.
Currently it’s about zero which means that holding cash is protected from inflation, but gives no real return.
Markets have become so used to negative interest rates on cash and lots of liquidity (QE) that they are unnerved by this changing.
However, the US economy is booming, unemployment is the lowest since 1969 and growth is close to 4%.
There is no reason to keep rates at crisis level lows any longer and in fact they should be back to more normalised ranges, to balance the economic decision-making process.
Pretty much any investment can be justified if holding cash produces negative returns; the bar for investment decisions in terms of acceptable ROIC (return on invested capital) in this scenario is only a few inches off the ground which distorts calculations and the longer rates are low before rising, is increasingly likely to end badly.
The China trade issues had been bubbling away for months prior to this October downturn but where previously markets were in sanguine mood and adopted a fairly laid back view that all would resolve itself in time, now pundits are suddenly screaming that this could go on Indefinitely and all is therefore terrible.
China’s latest trade figures came in at the expected 6.5% growth but then they pretty much always do. In calmer times people gently raise an eyebrow to the frankly less than wholly believable symmetry of their evolution and in bad times as now, throw hands in the air and go “yeah sure that’s true!”
Brexit continues its tortuous journey to, one assumes, a fudged resolution.
As we have said previously, the major obstacle was always going to be the Irish border issue which in terms of hot potato political grenades is up there with the most explosive.
Although Brexit is of course a huge deal for the U.K. it really isn’t for the global markets and as per various blogs a bad Brexit will not necessarily be a negative for portfolio performance as a whole. The majority of the holdings are non-sterling denominated which will rise in value if the pound falls.
Which it almost certainly will do if there’s no deal.
As regards the Italian debt issue, honestly, it’s a mess; has been so for a long time and isn’t going to change so it blows up, it blows over, it blows up again. Rinse and repeat in all likelihood.
A massive design flaw of the Euro is the highly indebted and more profligate Southern European countries no longer have the ability to effectively shrink debt by devaluing their currency.
This will continue to cause major problems; on the one hand there is a powerful political will to keep the Euro intact, and on the other is the ongoing refusal of Germany to consider Euro bonds backed by the bloc as a whole, which would significantly reduce the issue.
So, you have one currency but each Euro country issues its own debt instruments, really not a good mix.
CONCLUSION
As we suggested could well be the case returns in 18 have been low after a stellar 17.
Most markets are flat to down currently for the year, with only the US (of the major markets) being positive.
This is understandable because US economic growth is currently far superior to any other developed nation.
Markets look to the future so will rise in expectation and fall in anticipation.
The question therefore to ask is, are there signs of a slowdown which could lead to a global recession (earnings falling not rising). The simple answer is no, there are no signs of that.
There are signs that:
- Interest rates are rising
- Liquidity is falling (Quantative Easing being reversed)
- Central Banks aren’t giving markets the pacifier of telling them they’ve got their back any longer
In short, it’s all going back to a more normalised and balanced situation which it should.
But
Great companies are still growing profits at 15-25% pa on very reasonable PE ratios and no stock market looks overvalued.
Now bonds and property, well that’s a much cloudier picture. (See the next blog on valuing assets.
Bonds and Property – Part Deux).
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.