Fantastic news in the US causes global meltdown!
This recent bout of significant volatility and asset rotation started on the 2nd February 2018, when the US posted better than expected US wage data. The data was so strong it pushed up the US government yields on 10-year debt to over 3% causing a great deal of excitement, increase volatility and algorithmic trading.
Although this was great news economically, it was also a tipping point for global equites and a market rout has since taken hold and then stabilised and we are today watching closely to see if calm has again returned. Sometimes good news is bad news and if you are an investor looking at risk, when you could get a 3% return from a government bond compared to a 4.3% return on US equities, by way of a dividend with the risk attached to the equity, the question investors then ask is, why take the risk?
What happened the week starting the 5th February was a rotation in assets away from equities, made worse by panic selling on the Monday due to a fear that Interest rates were going to rise much faster than anticipated in the US, and the selling then made worse by algorithms over a 15-minute period on Monday evening. Then panic ensues and the Bears take hold and a correction globally is the new mantra.
One of the many questions our clients ask us is “Is this normal”?
In essence yes, but no one was expecting such a fast reversal in Q1 2018. We were expecting the start of the asset rotation and increased risks to start in Q3 2018 once the US rates had risen a bit further. Looking back at what we saw in 2008 though, what we are seeing is similar to what happened in the early part of 2008 when the last economic cycle was running out of steam and things were happening that no one understood or would listen to. That was also the last time (Feb 2008) we went into full capital preservation mode due to fear of an economic slowdown at the end of a normal cycle, but it was simple then as we could get 5% in cash, so not taking risk was easily rewarded.
The chart to the right is self-explanatory, and this shock is what worries me, as I feel we are in a similar position economically to then, and the direction of travel will be the same, with denial around risks coupled with rallies and then further shocks. Noting these comments though, we are accepting the risks are different and banks significantly stronger, so no one is expecting an economic collapse as we saw in 2008. We will though start to see an asset rotation, volatility increase and risks increase as we progress through 2018.
2018 is different and the chart to the right does not mean that we are forecasting a continued rout and global economic collapse, it just means that we are, as we have been saying, nearing the end of the cycle and fear of faster interest rate rises means a faster asset rotation. This is not good for equities and is what always happens at the end of the cycle and is part of the process to identify the party is starting to end. Even though this is or has been a goldilocks period as we have been saying, be careful in chasing the cream at the end as it can sometimes turn sour and give you a nasty surprise.
As no one knew how bad the rout was going to be we felt the need to partially deploy our capital preservation mandate by selling some of the equity we hold, in part to draw a line, but still keep enough exposure to some equity and ensure there is a balance in the portfolios.
Our logic for this is simple in that we see very little upside at the moment and significant downside and staying invested in that environment with the fund managers that have a long equity mandate is against our ethos and they have therefore been in the majority sold. This has significantly increased our cash holdings temporarily whilst we observe, and we will look to redeploy half of that over the coming weeks as markets settle, and some sense prevails. We then intend to deploy the remaining cash into oversold positions and technically trade indices or just hold cash as a hedge against risk and uncertainty. If it looks like the global economy is taking a turn for the worse due to the accelerated slowing of the US economy, we will then also look to buy UK government debt.
It is likely that by year end we will have reached a peak in the interest rate cycle and as such government bond yields in the US will be more attractive than equities and this will cause a global resetting of equity prices. If this coincides with a slowdown in the US consumer demand and a high US$ then the latter half of 2018 and 2019 will be awful for equities.
We would rather not lose money in 2018 and deliver more stable outcomes and preserve capital, then have capital to buy into a real fall as we have done historically. There are many months to go before we get to that point though and many more gyrations up or down which we have to travel through. It is going to be more volatile than 2017 but we will do our hardest to protect your capital and be a safe pair of hands. Greed helps no one and only comes before a fall.
Please note past performance is not a guarantee of future performance.
As always if anyone would like to discuss any aspect of our trading style please contact us on 01604 238880.