As Mark Twain was famously quoted “history never repeats itself, but it rhymes” is ……for October 2018 past. I prefer the more recent lines from a Split Enz classic “history never repeats I tell myself before I go to sleep. Don’t say the words you might regret, I lost before, you know I can’t forget!”.
October is a unique month. In the west (and the US being the world’s biggest market), October is a transitional month, autumn sliding relentlessly towards winter. It also boasts the only holiday where people are encouraged to dress up, scare each other and extort candy with threats of mischief, a practise that has now become popular in Australia in more recent times.
October also has a special place in finance, sometimes referred to as the October Effect, and is one of the most feared months in the financial calendar. The events that have given October a bad name over the last (say) 80 years include;
Historically, the month of October has been a pretty challenging month for financial markets and unfortunately 2018 was no different. Over the month local markets were off about 6% and global markets, led by the S&P 500, were off close to 9%. This is causing some concern for many investors, leading to overall concerns about the direction of financial markets in the near term.
There have been plenty views on the ‘why’, but to borrow from Financial Keys’ recently appointed investment consultant, Chris Lioutas, he believes that understanding investor behaviour is always difficult, especially over shorter periods of time.
Chris goes on to say that from the information we’ve seen and the ongoing analysis conducted, we can see four main reasons for the current turbulent market movements:
1. US central bank policy (not new, ongoing concern)
2. US-China trade wars (not new, ongoing concern)
3. US technology stock valuations (new, shouldn’t be surprising)
4. Panic / algorithmic / ETF selling (potential opportunity)
As mentioned, the first two are ongoing issues, which continue to stoke investor concerns. The US central bank has turned a little dovish more recently softening some of their rhetoric, however, they remain somewhat clear that they expect to raise rates another 5-6 times over the next 12-18 months before stopping their tightening cycle. In contrast, market expectations are that they stop after 3-4 rate rises (middle of 2019) as the US economy rolls over and gets too soft for them to raise any further. At this point, it’s a 50/50 bet either way.
The consequence of higher cash rates is the impact on bond markets. Bond yields have moved higher over the last couple of months and that’s led to some rotation (selling / buying) between equities and bonds.
On US-China trade wars, the market got a little optimistic earlier in the month that some sort of common ground might be reached when President Trump and President Xi meet, which may pave the way for the end to the trade conflict. That optimism was short-lived. It is obviously in both Presidents’ best interests to find some common ground. The trade wars are having a material impact on global economic growth, with growth rolling over in Europe and Japan more recently, and manufacturing and other business data down quite sharply as a result. Business and investor sentiment and confidence has been sapped.
On US technology stocks, the falls that we’ve recently seen were somewhat inevitable given the unnecessary rally we saw this year up until September. Case in point, Amazon’s share price went from $1,189 to $2,039, before closing at $1,516 (21 Nov 2018).
Did much change at the company level in that time? NO. Is anything fundamentally wrong with these technology stocks? NO. They generally have little to no debt on their balance sheet, sky high margins, significant volume growth, and earnings growth compounding annually in the high teens to early twenties. Nothing wrong with that picture. However, more recently investors have begun to question how sustainable those earnings are into the future, and the recent company reporting season showed investors move their attention to revenue growth (top-line) rather than earnings growth (bottom-line), effectively using revenue growth as a barometer for sustainability of those earnings.
We agree that technology stocks should demand a premium price and hence valuation, but that does need to be kept in-check from time to time. Extrapolating recent or current growth into perpetuity is plain stupid.
On panic / algorithmic / ETF selling, whilst panic selling is not new, and we’re definitely in the midst of it right now given equity valuations look rather compelling, the paradigm shift comes from algorithmic and ETF selling. Algorithmic (automated) trading, simply, involves computers programmed to follow a defined set of instructions at a speed and frequency that’s impossible for a human trader to replicate. ETF buying and selling involves indiscriminate buying and selling of whole markets - regions, countries, sectors, sub-sectors, themes, etc. Once panic or trends set in, indiscriminate selling results in quicker and sharper down movements, which can be hard to reverse. We’re seeing more and more this of late.
Potentially, especially if trade wars escalate from here and/or if the US central bank mis-reads conditions and goes too hard on rates i.e. continues to increase rates. However, we see the recent downturn as a somewhat rational pull-back (for those not panicking) and plenty of opportunity for those investment managers with excess cash, those who have been waiting for a better price point to buy back into the market.
As mentioned above, equity valuations remain undemanding and some markets look very cheap at present, all with a long term view in mind obviously.
When these type of market conditions prevail, noise of recession starts to hang in the air. It might be useful to consider the following points;
Don’t panic. Whilst volatility will continue to rise from here, that will also mean opportunity for those investment managers holding cash. Fundamentals look sound even in light of some economic and political headwinds arising. Don’t get too caught up in the near term and avoid selling low and buying high at all costs. Analysis shows that missing the best 50 days over the last 20 years in Australian equities resulted in a 0% return versus a near 9% return for those that remained invested.
While it’s not easy for investors when they see significant financial market moves, it’s important not to overreact to headline ‘news’. Decisions need to be fundamental in nature. It is important to look at where the market is heading in the near and long term so as to best position portfolios to take advantage of those opportunities as well as manage portfolio risk.
While we take on Chris’s comments above, as always, the team at Financial Keys welcomes your call to discuss your portfolio in detail or any updated views that we might have on global investment markets.
The Australian equity market (ASX 200), although starting the quarter in good spirits and continuing to rally, driven by lower-than-expected inflation data and positive sentiment, witnessed an acceleration in market volatility due to various economic and political factors. This did not deter investors as the index made history on 17 July by surpassing the 8,000 mark and closing at an all-time high of 8,057. Off the back of positive momentum supported by optimism of interest rate cuts by the US Federal Reserve as early as September the benchmark delivered a strong quarterly return of +7.8%.
A new generation of just over 5 million Australians – born between 1965 and 1980 – are approaching their retirement years.
The Australian equity market (ASX 200), ended the quarter in the red (-1.1%). Higher than expected year-on-year core inflation readings flowing through from the March quarter attributed to the weak performance whilst market anxiety also increased at the thought of a possible rate hike - a long way away from the cuts that had been priced in earlier in the year and in late 2023.