Roller Coasters & Defensive Back Fours

Yesterday the FTSE 100 fell to its lowest level since August 2012. The sharp global stock market falls in the last six months have been attributed to fears of slowing economic growth in China. However China has had a side-kick to gang up on stock markets – the falling oil price.  A clear linkage exists between the two. Both are signals of a weakening global economy and hence lower future company earnings. More recently oil seems to have been the main driver of stock markets with a very high correlation between oil and shares. China seems to have moved to the back burner.

A falling oil price can be viewed as glass half empty or glass half fall. Net oil importing economies such as Japan, India and Germany benefit from low prices and they are a boon for consumers with lower energy and petrol costs. Historically a falling oil price was seen as positive for the economy. However this time around the savage drops in the price of “black gold” since the summer of 2014 has been negative. Aside from job losses, falling share prices of oil producing companies,  sovereign wealth funds of oil producers have liquidated investments to make up the shortfall from oil revenues further driving shares lower. However I suspect it is the signal that all is not well with the global economy that has been prime factor in the equity sell-off.

That said I was surprised to have learnt yesterday that questions have been raised about the financial stability of Deutsche Bank, Germany’s largest, after concerns about the bank’s ability to pay interest to its bond holders. Its shares fell 8.5% on Monday, a further 5% yesterday and are down 40% this year (Source: BBC News website). The Chief Executive and the German finance minister yesterday sought to reassure investors but despite this fears have been raised about another financial crisis and the stability of the banks. In one sense this is a bit of a shock given the significant measures central banks and regulators have undertaken since the crash of 2008 to bolster the banks. These included additional capital adequacy requirements, stress testing and more stringent lending criteria. The problem with the banks is their balance sheets are notoriously complex and opaque and the inherent risks difficult to spot. Neil Woodford, arguably the best UK fund managers famously stated a few years ago that he was avoiding investment in the banks as he did not understand them!

What seems to have happened is a morphing of the crisis from China to oil to banks. Alarm bells are ringing that we may be on the verge of another financial crisis. For most investors the general advice is to stay invested. Why crystallise losses or low prices? A buy and hold investment strategy is about staying invested for the long term and riding out the volatility. Anyone who invests in stocks be that equities or bonds has to accept the ups and downs. If you go to a fairground you should expect a roller coaster ride, not a gentle narrow gauge rail ride on the flat.

Finally it is times like this that reminds us that every investor needs a cash buffer, a chunk of savings they can draw on in an emergency or for short term capital expenditure. Cash is the defensive back four which protects your equity investments at times like this. It stands solid and prevents you becoming a forced seller. Using a football analogy equity funds may be the high profile parts of your portfolio, the strikers like Harry Kane or Jamie Vardy who score all the goals, but it is the defensive players who provide the security and freedom for them to do so.

The contents of this post is intended to be my own general economic and investment commentary and not an invitation to make investment decisions. You should seek individual advice before making investment decisions including selling funds.