11 January 2019

Don’t be too gloomy

It’s worth remembering that good businesses adapt to their environment and successful investors tend to be natural contrarians that relish moments when all around are despairing.

This time last year we described 2017 as having been the “year for the risk takers”; 2018 was not. It was, in fact, a tough year for investors in almost all assets. While investors were happy to buy into assets traditionally considered to be more “risky” (such as emerging market equities, smaller companies and junk bonds) on the hope of high returns during 2017, the crowd went in the opposite direction in 2018, as greed turned to fear; a clear example of this was the spectacular crash in the price of Bitcoin during the year. This switch from market optimism to pessimism gathered pace through 2018, culminating in Wall Street delivering its worst December performance since 1950.

Before allowing ourselves to get too gloomy, it is worth running through some of the main reasons why market sentiment has changed. Continuing with the contrast to 2017, we gave two main reasons for the positive performance that year; firstly, a healthy global economy and, secondly, dovish monetary policy. Both of these evaporated during 2018 and are key to why investors have been getting nervous. The global economy looks less positive than it did a year ago, as indicated by, amongst others, declining commodity prices and poor car sales. China is a clear swing-factor in global growth and their rate of progress has moderated this year. At this point it can be said that the economy has slowed down from an abnormally strong period. The big question is whether this is shorter term reversion to the mean or the beginning of an uglier recession.

Central bankers believe that there is no immediate reason to panic, with Federal Reserve Chairman Jay Powell describing the economy as being ‘in a good place’. This leads to our second point, that monetary policy has become less supportive recently as US interest rates have now risen nine times since bottoming in 2015 and new money is no longer being pumped into the system via quantitative easing (QE). It has to be remembered that in the decade since the financial crisis of 2008/9 we have witnessed the biggest and longest use of monetary support in history and that we are now only just peeking out the other side. Central bankers are seeing if the economy can survive when the stabilisers of low interest rates and QE are off. So far, it has been a somewhat wobbly ride.

No comment on 2018 (or indeed 2016 or 2017!) would be complete without mentioning Trump and Brexit. Extraordinary amounts have been written on both and we will try not to add too much more. From a market perspective, the uncertainty caused by the Brexit negotiations, trade wars and US Government shutdown are unhelpful in the short term, but have the potential to be a serious headache if politics get in the way of economic progress. Call us optimists, but history tells us that businesses adapt and move on from political change. In the UK particularly, respite from political turbulence would be welcomed by businesses and markets alike.

In the current volatile market conditions it is especially important to remember that it is not all bad. The most successful investors are natural contrarians that relish moments when all around are despairing. We are certainly not at this extreme of market capitulation, but we are closer to this opportunity than we were last year. It does not hurt to listen to Monty Python from time to time and look on the bright side of life.

Written by Fred Mahon

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