The Small Print

The contents of these muses are my own opinions, should not be taken as a personal recommendation to invest in the areas mentioned and does not replace the need for individual independent advice.

Upbeat on the UK

When I read articles this morning from two independent investment commentators making positive assessments of the UK stock market I had to take note. For those of you who follow the figures the FTSE 100 has recently posted a new record closing high and is threatening to hit 8,000. So what is going here? Russ Mould, Investment Director at AJ Bell cites four factors that are driving returns:

1. The FTSE 100 index has underperformed its global market peers in 2016 and 2017 and is attracting contrarian investors with a bullish outlook. Brexit uncertainty has undoubtedly been a key factor in creating poor sentiment.

2. The UK is an unloved and undervalued market. It is not expensive compared to its international peers and relative to its historical earnings.

3. The dividend yield is above 4% p.a. attractive to income investors.

4. A weak pound has boosted the overseas earnings of UK companies and makes the UK a more attractive place to invest.

I would also add a rising oil price has boosted the commodities heavy FTSE 100 index specifically the oil majors. For example Royal Dutch Shell B shares have risen 29% in the two months from 19/3/18 to 21/5/18. This is highly significant as Shell and BP are the 1st and 3rd biggest constituents of the FTSE 100 by market capitalisation, so when their share prices motor the index puts on the after burners.

Coming at the UK market from a broader economic perspective Neil Woodford is similarly upbeat. He argues that economic fundamentals are improving and the consensus view has been too pessimistic. Woodford is a contrarian by nature, so cynics might claim, “he would say that wouldn’t he!” Woodford cites multiple factors including higher employment, less inflation, wage growth, better public finances and a recovery in manufacturing and exports. In addition he argues that valuations are very attractive in out of favour domestically focused companies. For example he considers housebuilders and retailers are far too cheap and growth expectations are too low. He predicts a recovery in 2018 and has positioned his portfolios accordingly.

From my perspective I am minded to agree although I remain very bearish on UK retailers. In addition I have had a long term bias to smaller companies in the UK and elsewhere and instinctively prefer additional allocation to them rather than to FTSE 100 companies, certainly for UK domestic exposure.

The content of this blog is my own understanding of the UK economy and stock market. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Second quarter rally – Is the pesky blonde girl back ?

In the last investment blog I reported that global stock markets retreated in the first quarter of 2018. How things change! Half way through the second quarter there has been a marked improvement in investor sentiment and stock returns. The FTSE 100 index for example closed yesterday at 7,711, a significant recovery from its March 26th low of 6,889 and not far off the all-time high of 7,769 on January 15th. Other market indices have rallied albeit not to the same extent. So what is going on? My reading is there has been a combination of positive factors. One commentator from The Street suggested that in the US first quarter company earnings were impressive but investors have taken time to appreciate this. In the UK inflation fears have abated as economic growth has slowed and according to Charles Stanley & Co Ltd the Bank of England, expected to raise interest rates just a few weeks ago, voted to keep them at 0.5% p.a.

On theme of inflation various commentators including the Chief Economist of Invesco Perpetual, John Greenwood have noted the normal Phillips curve has broken down. The Phillips curve is an inverse relationship between the unemployment rate and inflation. The argument goes as unemployment falls inflation rises and vice versa. It is a very logical assumption borne out in the past by actual data. As unemployment falls not only are there more workers earning and spending but the shortage of skilled labour drives up wages. However in the US Greenwood noted that the tight US labour market has only had a modest impact on wages between 2009 and 2017 and the Phillips curve has been almost flat with a similar result in the UK, Germany and Japan. With inflation fears abating interest rate expectations are muted. This scenario is good for both bonds and equities.

Greenwood also concluded that fears of a US recession are misleading. He said there are three key indicators of recessions and all cases evidence is lacking:

1. The yield curve being inverted. The normal yield curve is based on interest rates on government bonds being correlated with the maturity date of the bond i.e. the longer the term the higher the interest rate paid. This is because investors in longer dated bonds demand higher interest rates to offset the greater risk of uncertain future inflation and interest rate rises. Greenwood noted the yield curve is not inverted and unlikely to become so in the near future.

2. A sharp slowdown in money and credit growth. These have been low and steady for several years.

3. Over-leveraged balance sheets; too much debt in plain English. Consumer balance sheets are in good shape and Greenwood reckons even if interest rates do rise US consumers should be resilient.

In conclusion Greenwood stated that in the US, Japan and the Eurozone low inflation will continue for the next few years and there is a low risk of recession. Greenwood is someone I respect and listen to. I find his analyses of the global economy to be measured, balanced and compelling.

Other factors have contributed to the recent market rally. The easing of tensions between North Korea and the US has been positive, although this has been followed by a deterioration in the Middle East, with the US pulling out of the Iran nuclear deal. The technology sector has recovered from its mauling earlier in the year. Charles Stanley’s Chief Investment Commentator, Garry White noted in a recent blog that Apple shares have climbed to a new high whilst Facebook has clawed back its losses from the Cambridge Analytica data harvesting scandal. Finally mergers and acquisitions are expected to spike in 2018, driving stock prices.

In the first quarter Goldilocks did a runner (see blog of 24/3/18). The bears ate their porridge in peace. However it seems Goldilocks was just being sneaky, hiding in the woods and is now ready to make another foray into the bears’ house in search of goodies. Perhaps the not too hot, not too cold economy is back. We shall see.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Markets Retreat in Q1 2018

Global stock markets ended the first quarter of 2018 down. Data from HSBC Global Asset Management and Datastream showed the following index returns,*

UK Equities: -7.3%

Asia Pacific (excluding Japan) -7.2%

Japan Equities: -5.5%

European Equities: -3.3%

Emerging Market Equities: -2.3%

US Equities: -2.2%

*MSCI are an independent producer of stock market indices widely used in the industry. These are total returns including re-invested dividends.

You will recall there was a sharp global stock market sell-off at the end of January and early February, and generally negative sentiment and higher volatility in evidence since then, triggered by fears of a trade war between the US and China. Property and investment grade corporate bonds also fell during the quarter whilst global government bonds rose a tad, 0.3%, in the first three months. On Monday 5th February the Dow Jones Industrial Average plunged more than 1,500 points, its biggest one day fall in history. In percentage terms however, the drop was more modest and certainly not a record.

The principal reason for the February sell-off was a fear of rising interest rates in the US caused by stronger than expected wage growth. Perversely, good economic data is sometimes viewed suspiciously by investors. Whilst rising wages should boost domestic spending and lead to a reduction in personal debt, they threaten a spike in inflation. Moreover wage growth for employees is an added cost for companies and a drag on their profits.

The first quarter of 2018 has been a wake-up call for investors who had become rather complacent given that 2017 was a very benign year with strong equity returns and very low volatility. Commentators are now calling the end of the Goldilocks economy, one that is not too hot or not too cold and doing very nicely, thank you very much. So what is the problem? When inflation bites bond prices fall and yields rise. For example the benchmark 10 year US Treasury yields recently hit 3%, for the first time since January 2014. This means investors can now buy “risk free” government debt and earn 3% p.a. so rising yields tempts investors out of equities and into bonds.

What I found surprising though is that US equities fell much less than in UK equities in Q1 2018 and less than in other markets. This is odd given the trigger for the market falls in February was an issue with the US domestic economy. When America sneezes the world catches a cold, but the US proved more resilient this time around.

To finish I thought it would be instructive to see how a number of targeted absolute return funds and cautious multi-asset funds I have recommended to clients have fared over the same period. These should have protected capital, if not in absolute terms, relative to pure equity funds. Here are the results, they are total returns including dividends or interest re-invested and are net of all fund charges:

M&G Episode Income: -0.67%

Henderson UK Absolute Return: -1.3%

Baring Multi-Asset: -2.5%

Santander Atlas Portfolio: -2.73%

Cornelian Cautious: -3.23%

Premier Multi-Asset Distribution: -3.26%.

Clearly all funds performed better than UK equites, a key comparator for UK investors, although none provided absolute capital protection over the quarter. To be fair most of these funds do not target a positive return over all periods.

The last three funds lost more than I might have expected but I don’t judge investments based on three month performance figures. A final point to make is that charges are not relevant to index returns, unlike with managed funds. In many cases these are more than 1% p.a. when transaction costs are taken into account.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Dark Clouds Looming over the Bears’ House

For much of 2017 and the beginning of 2018, various commentators pointed to a Goldilocks economy, one that is not too hot nor not too cold. It has been characterised by synchronised economic growth around the world, with muted inflation and supportive central bank policy. It was also a period of rising stock markets and unprecedented low volatility. It proved to be the calm before the storm. Since January we had a sell-off from bonds and equities on fears of US wage inflation and rising interest rates, followed this week by breaking news of a looming trade war between the US and China. Volatility and the so called fear index has spiked and equity markets tumbled again. All this has taken place in a backdrop of a sea change of policy by central banks to gradually turn off the supply of easy money, the reduction and reversal of QE.

Another concern highlighted again this week has been with UK retailers with major names announcing profits warnings, cut backs and restructuring. The list of firms in trouble in the last few months has been growing. Toys R Us went into administration a few weeks ago whilst Next announced a fall in profits on the back of the most challenging trading conditions for 25 years. Carpetright is in trouble and Prezzo, an Italian restaurant chain is set to close more than 90 outlets. There a clear theme here that the High Street is in trouble. It is not just the corner shops and independents but well known chains too. Lots of people are set to lose their jobs.

It seems as if consumers are not spending. To what extent fears about Brexit are weighing on the British public I don’t know, but those with variable rate mortgages may be more cautious with interest rates rises expected down the line. It is clear the problems with the High Street are multifaceted with some retailers failing to adapt to the rise of online shopping. However I cannot help put blame on what for me is the most unfair, retrogressive tax in the UK – business rates. Many businesses recently have had to cope with double and even triple digit rises in business rates, due to their linkage to local property prices. For example last year traders in upmarket Southwold in Suffolk faced rate rises of up to 177%. What I intensely dislike about business rates is that it is a tax on a shop simply opening its doors to trade, whether it sells anything or not. The business may have a low turnover and make a loss and yet it is still taxed on its rateable value. In contrast most taxes are based on ability to pay – the more you earn the more income tax you pay, the more you can spend in the shops the more VAT you pay, the more expensive the house you can afford to buy the more stamp duty you pay. I for one would like to see a much fairer system of taxing retailers in the High Street one that is based on turnover or profits. Moreover a level playing field is required with online retailers. During the business rates revaluation I understand Amazon saw its bill drop due to its distribution centres being located in less fashionable out of town locations.

So what do I conclude for investors. I have been cautious on equity markets for a long time now and throughout 2017 I have been advising clients to reduce risk, take profits and invest cautiously. That is still my position although I still advise selective equity investment. The tremors in early February and now this week may be early warnings of a bigger shock to follow. Time will tell. Ensuring good foundations, having a solid defensive portfolio offers the best protection in an earthquake. Let’s hope the house of Papa bear, Mama bear and Baby bear stand up. After all we wouldn’t want the porridge to get spilt, would we! As for Goldilocks she seems to have disappeared.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Lions, £50 Notes, Bitcoins and the Yield Curve

I came away from a lunchtime investment seminar in Brighton on Thursday with lots of thoughts, a pack of fund brochures and a cuddly toy – a lion. No surprise perhaps since the company hosting the event was Liontrust Asset Management. They are a relatively small independent and respected fund manager with strong investment returns. Presenting was head of multi asset at Liontrust, John Husselbee, an experienced investor who has “run money” for 30 years. This is in house jargon that fund managers often use. I subsequently had visions of a 100 meter race between a fund manager and a £50 note, but enough of the trivia. The key point is he has seen it all from the dot com bubble to the financial crisis. In contrast some young fund managers may never have managed investments through a stock market crash.

Husselbee started his presentation with a compelling argument that by protecting capital during sell-offs investors have less losses to recoup when markets rise. Consequently reducing the downside is crucial in achieving good long returns. From June 2011 to December 2017 a multi-asset portfolio he co-manages matched the total return from the FTSE 100 i.e. including re-invested dividends – but crucially with significantly lower volatility. This is pretty impressive given the fund in question only held 56% in equities at the end of the period. The principle here is winning by not losing. The outcome is good returns and with lower risk.

Husselbee then covered Bitcoins. Clearly some people have made fabulous returns from this cryptocurrency but that in itself is not a reason to invest. First Husselbee highlighted a graph that showed a remarkable correlation between the vertiginous rise in the price of the Bitcoin and google searches. It strongly suggests that prices have been driven by a fad and a mad scramble to buy, not by compelling investment fundamentals. Whilst Bitcoins have features that might identify it as a currency, for example some retailers accept payment in Bitcoins, its price is far too volatile to be considered a credible currency and it has no central bank backing. Moreover on what investable means Husselbee quoted the highly respected economist and investor, Benjamin Graham. He wrote in a landmark book of 1949, “The Intelligent Investor,” that:

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

Husselbee concluded as I do that the Bitcoin is not an investable asset but a speculative one. In fact I have not come across a single fund manager who includes it in their portfolios.

Another take-away for me from the presentation was the mixed messages about the global economy from the bond and equity markets. An OECD* study showed global strong and synchronised economic growth in 2017. The organisation monitors 35 OECD and 10 non-OECD economies and in 2017 all were expanding with a majority demonstrating accelerating growth. Not one was contracting, the first time this occurred since 2007. Last year equity markets rallied on the back of this positive backdrop combined with strong company earnings. In contrast the bond market is more pessimistic about the global economy. Here it gets a little bit technical but I’ll try to explain it simply. Economists and fund manager place a lot of store in what is called the “Yield Curve.” It refers to the chart of yields of government bonds with different maturities. Typically the normal yield curve shows that long dated bonds have higher yields or interest rates than shorter dated issues. This is because investors demand to be rewarded for the risk of future inflation. When inflation or interest rates or expectations of such rise bond prices fall and yields increase and the shape of the curve changes and vice versa. Longer dated bonds carry the most risk. However since 2014 the difference in the yield between US Treasury 10 year bonds and two year bonds fell from about 2.6% to about 0.5% in early 2018, before a spike to around 0.75% during the recent market sell-off at the end of January. In other words in the last four years the flattening of the yield curve means the bond market has been pricing in low growth and inflation, arguably even recession. Of course this period has coincided with very accommodative central bank policy and QE life support. I asked Husselbee what he considered the more reliable indicator – the equity or bond market and surprisingly he said the former. Instinctively I would have thought the equity market was given synchronised global economic growth. I conclude the mixed signals must make fund management a tricky business and being cautiously optimistic is probably a good middle ground, not being too gung ho nor too defensive and being selective in what you choose to invest in. Add a dash of flexibility and this probably a good recipe for fund managers.

Finally Husselbee’s presentation emphasised the need to ignore headlines (news events such as the UK snap election, the North Korea crisis or Catalonia) and focus on fundamentals. He also suggested Trump’s economic policies have yet to benefit the US domestic economy as evidenced by the fact that since his presidential election victory in November 2016 US smaller companies have significantly lagged US larger firms. On another point he and his highly experienced co-fund manager, Paul Kim, have tilted their portfolios from growth to value with expectations of rising growth and inflation.

In conclusion I thought Husselbee talked a lot of common sense, he has a clear and compelling investment philosophy which he articulates well and he clearly understand markets and what consumers need. For example he expressed some mild exasperation at regulators who in seeking to improve transparency end up making things more complex and confusing, a view I wholeheartedly share. For example under the new MIFID II** rules which require disclosure of fund transaction costs you can end up with a negative figure! Yes, that is true. It implies a fund manager can undertake multiple trades each year within his or her portfolio and incur no expenses in doing so, for example stock broker fees or stamp duty. Not only that someone plucks £50 notes from a money tree and pays that to the fund.

I may have said this before but I tend to buy fund managers more than funds. It is not easy to articulate but every now and again I listen to a fund manager, something connects and I think I really like the way he sees markets and manages investments. I can see myself entrusting client money to him and his multi asset funds.

*OECD is the Organisation Economic Cooperation and Development

**MIFID II is the EU’s second Markets in Financial Instruments Directive, a complex and bureaucratic piece of legislation affecting fund managers and IFAs alike and which the FCA adopted. It came into force on 3/1/18.

The content of this blog is my own understanding of the global economy and stock markets based on John Husselbee’s presentation. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice, for example to buy Liontrust funds. You should seek individual advice based on your own financial circumstances before making investment decisions.

Stick or Twist – Time to Sell?

Following a review I advised some clients to undertake risk reduction and profit-taking from their investment and pension portfolios by switching selected amounts from pure equity to cautious risk funds. In response although they were happy with my advice they raised a perfectly reasonable question. Should we wait for a recovery in the equity markets before selling from the equity funds I recommended? Here is the gist of my reply.

The issue you raise is a difficult one to call as we do not know how serious this correction is. Waiting for the recovery instinctively makes sense given the sharp falls on global equity markets. Overnight the Dow Jones fell more than 4% whilst in Asia the Nikkei and Hang Seng fell more than 2% and 3% respectively. With ongoing volatility the fallout could continue, equity prices may drop further and markets may enter a longer term slump, suggesting selling pure equity funds later will not prove beneficial. If however there is a V shaped recovery in the near term it suggests waiting to sell is best. We just don’t know whether the slide will continue or reverse in the short term nor the medium term direction of markets, so do we stick or twist?

In favour of selling now is the argument that in some cases market indices have fallen back to their levels of just a few months ago. For example the Dow Jones peaked at 26,616 on 26/1/18. It has fallen to 23,680, its level on 29/11/17. The Hang Seng is now back to levels at the end of December 2017. Your portfolio was very profitable then and had I been advising you a few months ago I would have advised risk reduction and profit-taking. You can see that an emotional reaction to the short term volatility can cloud the fundamentals here. The FTSE 100 however has fallen back to levels last seen in May 2017 and so arguably the reversal is more significant.

In favour of waiting to sell is the strength of the underlying global economy suggesting the fundamentals are supportive of rising equity prices and the recent falls are just a correction to somewhat exuberant markets rather than the initial tremors preceding a global financial earthquake.

In conclusion I am happy to hold fire on all recommended pure equity fund sales. The alternative is we still proceed but reduce the amounts sold by a fixed 10% to account for the market drop. I could also undertake the sales on a phased basis, some today and some next week perhaps over several days. What this achieves is better prices if markets rally next week. The risk is of course that prices continue to fall and the later sales are at lower prices. It is a difficult decision and I am struggling to say what is the best to do. However if I have to get off the fence I would say sell all that I have recommended now reducing the sums by 10%, remembering I have not proposed disposing entirely of profitable equity funds. You will maintain substantial equity investment. What this means is you will still participate in a market recovery whether in the short or medium term. The risk of selling now at lower prices than a couple of weeks ago is arguably not too significant. You will only bank strong profits as opposed to very strong profits.

This blog is intended as general commentary only. Please note this advice is specific to these clients and should not be construed as general advice that other investors sell-down pure equity funds. Nothing in this article is intended as personal investment advice to my readers. You should seek individual advice based on your own financial circumstances before making investment decisions.

Global Equity Markets Slide

Last Friday the Dow Jones Industrial Average fell 2.5%, its biggest one day fall since June 2016. In the week as a whole the index fell 4.1% whilst the S&P 500 dropped 3.9%. The latter as you may recall is more representative of the US economy as a whole. The trigger for the falls was a sell-off in government bonds. US equities had a terrific start to the year, the best since 1987, on the back of the passing of a bill to slash corporation tax from 35% to 21%. The euphoria was hit by a sell-off in the bond market at the end of January due to higher than expected wage growth, inflation and fears of more aggressive interest rate rises. On January 29th in the US the benchmark 10 year Treasury yield rose to 2.73%, the highest since April 2014. To remind you of the relationship between bond prices and yields, when prices fall yields rise and vice versa. This is because a bond is issued with a fixed rate of interest, called the coupon. If the price of the bond falls the value of that coupon and the yield rises (see example at the bottom of the article).

The falls in the US bond and equity markets have now impacted global markets. As I write the FTSE 100 index is down 1.12% to 7,360 in morning trading, well off its peak of 7,778 on January 12th. Japan’s Nikkei 225 lost 2.55% overnight and the Hang Seng fell 1.09%.

So what do I conclude? It is too early to say whether this is the start of a major rout on global markets, an early warning of trouble ahead or merely a minor correction. In some ways the “correction” was entirely predictable. Concerted global economic growth was bound to fuel inflation and trigger rises in bond yields. The other question on a more positive note is to ask who are the potential beneficiaries of rising interest rates and market falls? It is widely agreed that banks and insurers benefit from higher interest rates whilst active fund managers with strong stock picking skills are likely to perform well, at least in a relative sense, compared to index tracking passive investments. Finally I have wondered if there is a self-correcting mechanism in the bond market. This may be simplistic but if yields rises it should attract income investors to buy, pushing up prices.

If a government bond is issued at £100 with a 2% interest rate the bond holder is entitled to receive a £2 interest payment or coupon each year. Once bonds are issued they are traded in the market and the price may rise or fall. If the price of the bond falls to say £95 and investors buy at that price they will receive the £2 coupon and the yield on the bond will now be (£2/£95) x 100% = 2.1%. At a price of £90 the yield rises to 2.22%. The converse also applies.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice, for example to buy financial stocks or bonds. You should seek individual advice based on your own financial circumstances before making investment decisions.

Black Tuesday – The History and Legacy of the Wall Street Stock Market Crash of 1929

This little book by Charles Rivers Editors made very interesting reading for me over the Christmas period. It was not technical and was written in layman’s terms so it is well worth buying a copy if this brief summary piques your interest. I can only do scant justice to the lessons investors can draw from these historic events in an investment blog.

The crash in October 1929 was the culmination to what became known as the Roaring Twenties, as the US economy and stock market boomed, driven by strong industrial production and new technology. Employment was high and prices were stable. Prior to 1920 few ordinary Americans owned stocks but as prices rose through the 1920s middle class Americans piled in, often buying stocks on credit or margin. Stock prices had a momentum all of their own and became detached from the real economy and investment fundamentals. From 1922 they rose almost 20% p.a. on average, although not uniformly. Although concerns were raised in early 1929 the market continued to rise fuelled by speculators. From May 31st to August 31st 1929 Westinghouse Electric Corporation rose 89%, Steel was up 56% and the market overall rose by just under 25%.

On 5/9/29 Roger Babson, an entrepreneur and economist predicted a crash at a meeting of the National Business Conference. It was a repeat of an earlier warning he made at the same time in 1927 and 1928. Babson’s comments evoked retorts from economists and stock brokers. For example Professor Fisher, a noted Yale economist claimed, “stock prices are not high and Wall Street will not experience anything in the nature of a crash.” In early October 1929 Thomas Lamont, head of Morgan Bank wrote to President Hoover, “The future appears brilliant. Our securities are the most desirable in the world.” Almost every business leader and banker was saying how wonderful things were and the economy was only going in one direction, up.

The Dow Jones Industrial Average peaked at 381.17 on 3/9/29 and then declined to 320.91 by 21/10/17. The sharpest declines then occurred on Monday 28th October, with the index falling 12.82%. This was followed on Black Tuesday, 29th October by a further drop of 11.73%. Further losses occurred subsequently and the Dow finished the year at 248.48, a decline of 34.8% from the peak on 3/9/29. This was followed by the Great Depression with 50% declines in industrial output and international trade. Unemployment rose to 25% and around 9,000 banks collapsed. The stock market continued to fare badly. In 1930 the Dow fell a further 33.76%, in 1931 it lost 42.67% and in 1932 the market was down by 22.64% (Source: https://tradingninvestment.com/stock-market-historical-returns/ ). If the Roaring Twenties was a heck of a party the Thirties was the mother of all hangovers, with the Great Depression going global. The cause of the Great Depression is still not agreed by economists but it may not have been simply due to the 1929 Wall Street crash. One observer noted that the market slump reflected the change which was apparent in industry and the economy. In other words the stock market merely acts as a mirror on the economy i.e. cause and effect runs from the economy to the stock market, not the other way around. I am not convinced about this argument but space does not permit me to express my thoughts.

There are several other interesting facts to note. Firstly the Dow Jones did not recover back to its former peak until 1954, 25 years after the crash. Secondly the biggest ever one day fall was not in 1929 but on 19 October 1987 when the Dow fell 22.61%. What is it about October? This sell-off in contrast to 1929 did not lead to a recession. Thirdly on the reasons for the crash an article from the New York Times on Tuesday 22nd October 1929 was illuminating. This was before Black Monday and Black Tuesday but after three days of losses in which billions were wiped off the value of shares. Five reasons were given for the falls which I paraphrase:

*Readjustment of stock prices to levels that are justified by earnings, economic fundamentals and company prospects.

*Unanswered margin calls from thousands of small investors. In order to cover the loan repayments or interest payments stocks were sold. This downward pressure on the market was enhanced by stop-loss orders. These are where investors instruct sales once a floor in the stock price has been reached.

*Foreign selling on a large scale especially in railroad stocks as overseas investors protected their interests.

*Short selling by investors taking advantage of a falling market.

*Negative sentiment amongst stock holders even those with profits. This is about investor psychology, rushing on mass towards the exit.

This analysis more than 87 years ago feels like a modern commentary on the causes of stock market crashes in more recent times. Nothing has changed. Once the slide starts it is like a snowball gathering pace and size as it accelerates down the hillside. Big market crashes are sudden, (the warnings and red signals are not but the immediate triggers are), sharp and self-perpetuating. Nothing has changed and although we have not had a crash since 2008 why should we think another is not coming? John Templeton famously noted that the four most expensive words in the English language are – “This time it’s different.”

So what do I conclude and why have I raised this subject now as my first blog in 2018? It is certainly not because I wrongly called a correction in late 2017 and am seeking justification for my view. Moreover I don’t believe the economy and stock markets in 2018 are anything like they were in the US in 1929. I don’t think there is a bubble in equities in general nor have prices become universally detached from economic reality. My concern is due to a bullish and perhaps complacent attitude amongst investors. The global economy is going through a synchronised recovery, central banks are cautious and accommodative and people made money in 2017 from equities. So why not again in 2018? My message is investors need to keep in mind a sell-off will happen again, no-one knows when, and plan accordingly. That does not mean avoiding equities completely but being cautious and investing a significant part of a portfolio in defensive assets. This will require adjusting expectation of returns from “shoot the lights out” performance to beating inflation or cash, more modest outcomes. Of course individual needs and circumstances will dictate the correct investment strategy and asset allocation, notably investment timescales, attitude to risk, capacity for loss and cash reserves. There is no one solution for all.

Finally it is worth Babson got it wrong calling a crash in 1927 and 1928 but then it happened in 1929. I got it wrong in 2017. I hope I also am wrong in 2018 and I would take no pleasure should 2019 prove to be a terrible year for equity investors.

The content of this blog is my own understanding of the 1929 Wall Street crash and the global economy and stock markets today. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Synchronised Global Economic Growth & Stock Returns

There is a wide consensus that in 2017 we have witnessed a broad based global economic pick-up. This has been accompanied by all major equity market indices posting strong gains with many hitting new highs. Emerging markets, Europe, the US and Japan have led the way. However within markets there has been a wide dispersion of returns. Leading UK fund manager Neil Woodford recently highlighted that in the year to 31/8/17, eight stocks accounted for just over 50% of the gain of the FTSE All Share index returns with the remaining 650 stocks making up the rest. These eight stocks were Unilever, Diageo, Glencore, Vodafone, Prudential, British American Tobacco, Rio Tinto and HSBC. Woodford concludes the UK equity market has been narrowly led by stocks exposed to Chinese credit growth.

On a similar theme Bill MacQuaker from Fidelity noted that just four stocks accounted for the two-thirds of the move in the MSCI Asia Pacific (excluding Japan) Index over the last year and if you missed out on holding these companies your returns would appear pedestrian. MSCI have created a very wide range of global and regional stock indices which tracker funds invest in. The MSCI World Index is a market capitalisation weighted index of 1,652 global stocks from 23 developed markets. The index rose approximately 18% over the first 11 months of 2017, a decent return. Whilst I do not have full data I suspect much of this rise is due to strong gains from a few companies. For example Apple the largest constituent of the index at around 2.27% is up nearly 47.5% in 2017 whilst the next biggest stock, Microsoft at about 1.44% of the index is up around 34.6%.

So what do I conclude from these observations? First it is clear that the broad based global equity rally reflected by index returns masks a wide disparity of stock returns within each market. This challenges the view that equity markets are universally expensive across the board. Certain sectors and stocks clearly are but good stock-picking fund managers will find opportunities to invest at decent prices in strong undervalued companies with good earnings growth. At the same time savvy investors might avoid the current winners. For example Woodford observed that whilst the share prices of the super eight stocks (my phrase), have risen sharply, earnings forecasts have lagged. For example HSBC has rallied around 66% since the June 2016 lows even though the earnings forecast is up only 5% in the current year. Conversely Woodford highlighted other companies such as Lloyds Bank and the AA where earnings growth has been good but share prices have fallen, in the case of Lloyds since its May 2017 peak. Domestic UK stocks now trade at a rare discount to UK exporters and it is in these domestic sectors such as healthcare that Woodford is investing. Aside from the opportunity set here, sector and stock selection is also about mitigating risk. If the Chinese economy stalls and the burgeoning bad debt bites the biggest stock fallers in the UK may well be the super eight. The positive side here is that other parts of the market with less bloated valuations should offer defensive qualities.

As we approach the year end I am pleased to have been proved wrong that I called a stock market crash, which didn’t happen. I think with hindsight I misjudged the equity markets to be universally highly valued. Indices might have peaked in 2017 but most stocks seem not to have joined the party, enviously watching from the side lines as the likes of Apple and the super eight jived merrily on the dance floor. Looking forward into 2018 I see selective opportunities for these bridesmaid equities. The word selective is key here. Active fund management should be favoured over passive index tracking. At the same time the risk of a hangover for the dancers could lead to a market correction.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice, including to buy shares such as Lloyds Bank. You should seek individual advice based on your own financial circumstances before making investment decisions.

Investment Intelligence

I regularly attend investment seminars for IFAs run by Invesco Perpetual called “Investment Intelligence.” In a presentation last week the speaker reviewed the global economy and markets and addressed the issue of the US Federal Reserve unwinding its Quantitative Easing or QE programme. As you are aware central banks in the USA, UK, EU and Japan have undertaken considerable asset purchases since the financial crisis to support the economy and their balance sheets have ballooned. The unwinding of QE called Quantitative Tightening or QT should not be confused with tapering. The latter is the reduction in QE purchases – the European Central Bank (ECB) will begin to do this in January 2018 whilst QT is the next step i.e. the disposal of assets that central banks have acquired. This has to be done carefully and slowly as wholesale dumping of bonds onto the market could trigger a collapse in prices. Instead in the US is as bonds mature there will be a reduction in the amounts re-invested by the Federal Reserve. Whatever the methods deployed and stages that different economies are at, tapering and QT are both clearly signs of recovery in the global economy.

This conclusion was a key message from the seminar. A recent OECD (The Organisation for Economic Co-operation and Development) study showed broad based economic recovery in all 45 countries surveyed with many exceeding forecasts. Whilst global equities have been the best performing asset in 2017, emerging market equities have outperformed. This is a reversal of a five trend of declines compared to developed market equities, a whopping 50% in relative returns. Improved fundamentals and a weaker US dollar have contributed to the turnaround. In summary the bull market in equities could continue as economic growth is anaemic and central bank policy is accommodative. The speaker observed that bull markets don’t die of old age, a phrase that is clearly catching on, and he cited Australia which has not had a recession for 26 years. The message I am hearing from various investment companies is we have a Goldilocks economy, even if that phrase is not used – one that is not too hot and not too cold.

In the UK, Invesco’s view is that inflationary pressures are easing. Technology is keeping down prices although unsecured consumer debt, for example car financing is a concern. Brexit considerations will of course be a key factor for the UK economy as markets hate uncertainty. Surprisingly UK larger companies have underperformed smaller ones despite the tail wind of a weaker pound which boosts the value of overseas earnings. This is because 60% of overseas earnings are derived from the US and the $ has fallen against the £ in 2017. In another presentation by Prudential I listened to last week the lack of dividend cover and profits warnings from FTSE 350 companies was highlighted. Dividend cover is the ratio of earnings to dividends. If too high a level of earnings is paid out to shareholders it can leave companies financial vulnerable and shareholders at risk of future dividend cuts.

Other takeaways were very high asset correlations and very low volatility. Gold however may be a hedge against equity market falls and can play a useful role in a portfolio. Whilst there are political risks overall the back drop for the global economy is benign. I have no truck with this analysis but I have said on various occasions previously stock market crashes may be triggered not by deteriorating economic fundamentals but irrational investor psychology. Caution remains the order of the day for me.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice, including to buy gold. You should seek individual advice based on your own financial circumstances before making investment decisions.