Further to our ‘taking stock’ initiative at the end of last year, we were able to take some profit and park this safely for the start of 2018. Taking the view that “a profit’s not a profit until it’s taken” worked pretty well because towards the end of January, things changed.
During February we had the appointment of Jerome Powell, the new chairman of the US Federal Reserve, and straight away he set out his stall, by saying he would raise interest rates four times this year.
Markets took some fright from this because whilst on the one hand it shows the US economy is doing well, there was concern this might drag on company profitability and the consumer, due to the rising cost of borrowing. It also became clear that the Fed’s view on Trump’s stimulatory tax cuts were not as enthusiastic, because they could create a short term bubble, and in the long term may not be sustainable.
These two issues caused global markets to wobble across the board, where equity markets fell around -10% to the start of April, and even cautious asset classes felt some stress because bonds don’t like a fast upward interest rate cycle.
Our view was to selectively drip feed into this volatility in our Q1 realignments, buying up some assets at a discount to hopefully benefit from a later upswing in sentiment. Whilst markets have since recovered, in the year to date, things are pretty flat.
So the Fed’s view, has been in some way to counteract the positivity of the tax cuts, whilst at the same time embarking on QT, Quantitative Tightening. This is the opposite of easing, and so in simple terms, rather than pumping money in, they would now be taking money out.
This is why apart from the technology ‘FANG’ centric Nasdaq, and higher risk smaller companies, US and world equities have been in the doldrums. In fact, the Chinese stock market is technically in a Bear market having fallen 20% from its recent high, and was down -13.9% year to date to 28th June, due to ‘Trade War’ tensions. It seems the Chinese are more concerned about the fall out.
Markets may over react, but they are rarely wrong, and so if they have been subdued what issues are playing out?
Interest Rate Rises ~ Central banks are desperate to normalise after 10 years of ultra-low interest rates. But in the interim ten years corporate and personal debt have increased. If rates rise too quickly, it could put stress on companies / consumers, and then slow down spending in the real economy. My take on this is that central banks want to raise rates as best they can without upsetting things, so that they have some levers to pull in the next slowdown. At the moment, if we had another 2008 situation, they would not be able to support things as they did before.
Trade War Tensions ~ Trump seems to have picked a quarrel with China, as well as most of his allies, including Canada , the UK and the EU. Whilst it’s anticipated the spat with ourselves, Canada and the EU will be diluted, the issue with China is much greater. Trump’s first round of tariffs officially come into force today 6th July, and China has already said it will do likewise.
European Banks ~ Absolute Strategy Research did a piece quoted in the FT last month, looking at global financial institutions deemed ‘too big to fail’. After the 2008 crisis an international list of 40 of these companies was drawn up. Their research as at 07/06/18 showed that 16 of these, had seen share price drops in excess of 20% from their 12 month highs, the worst being Deutsche Bank having seen its share price fall -44% from its 12 month high.
The Market Cycle ~ It’s no secret that stock markets have a blip every 7-10 years, it’s just that we choose not to dwell on the problems of the past. Over the last 50 years since 1966 we have seen a cycle of events, what used to be termed ‘the boom bust cycle’. Whilst QE and central bank support over the last ten years, lead some to say, ‘this time it’s different’, for those of an historical nature, its not really, as the following testify.
1966 S&P 500 fell -22% (Larry Elkin The Forgotten Crash 28/01/2014)
1973-75 UK stock market FT30 fell -73% ( at the time named the Second Great Crash )
1980/81 Savings and Loan Crisis in the USA, early 80’s recession
1987 Black Monday , Dow Jones fell -22% in one day
1998 Collapse of Long Term Capital Management, Federal bail out
2001-2003 UK FTSE 100 fell over -40% over three years, bottoming April 2003
2008/09 Global Financial Crisis, Bear Sterns / Lehman Brothers collapse
Rather than being morbid I think there are positives to take from this. Despite our worst fears the world keeps turning, and it does recover. Long term investment does work, but we also need to manage the short to medium term to stop us getting wiped out, especially those nearing or in retirement.
So there are some ‘chart watchers’ who are a little concerned that we may be reaching the peak of this recent cycle.
My mantra comes from reading Richard Branson’s first autobiography in the 80’s, where when evaluating a deal he would always think, … ‘Always protect your downside’.
Yes, I’m pretty cautious anyway, and experiencing the crash of 1987 as a junior with SG Warburg , that left a bit of a scar too, which led to trial and error over the last 25 years in developing a risk reduction process. Existing clients who were with me prior to 2008 will know we started switching from ‘risk to safety’ quite early, and where we were able to protect capital from the worst of it.
So in one respect if any potential clients are reading this, you are benefiting from 25 years of trial and error , … otherwise known as experience!
Taking Income ~ In a drifting market you have to review where, and how often you take income. Should this revert to ad hoc payments for example, rather than monthly? Should income come from across all funds or be taken from others, or just from cash ? Perhaps a larger cash buffer should be retained outside of the portfolio.
Cost Of Funds ~ By making savings here we hope to squeeze a little more return from a challenging market. In the next round of portfolio re-alignments, we will be tilting a little more to a ‘Smart Beta’ approach, a blend of passive and active fund strategies, using more low cost multi asset funds, and only using the slightly higher cost funds to access specific sectors we want to target.
Cost of Platform ~ We have already begun work in reviewing this and where we have been able to pass on savings in the running costs of client holdings. We will continue to be proactive in this regard to pass on what benefits we can to improve the bottom line.
Asset Allocation ~ This is our ‘unique sauce’, how we blend the funds together in the correct weightings, to not only protect the downside but also to advance the portfolio. As my peers read these updates too, I’m not going to specifically name funds here, but will be writing to you directly on this in the next few weeks. Needless to say we need to be adaptive and proactive.
Holding Some Cash ~ My views on cash come from Warren Buffet, who views cash as an option on the future, where having cash on hand gives us flexibility to acquire an asset at a bargain price. According to his biographer Alice Schroeder, this was one of the most important lessons she learned about the great investor, who said ‘cash combined with courage in a crisis is priceless’. It also helps protect the downside, if more risk is being taken at the top end of the portfolio.
Adaptive and Growth Orientated Mindset ~ Our approach is that we never stop learning and this is why we have a growth rather than a fixed mindset. Being adaptive has always helped us navigate some of the worst situations, perhaps seeking safe harbour, as our Safe Harbour Strategy did from 2008-2010. More recently I’ve absorbed some of the thinking from the ground breaking ‘Adaptive Markets’ by Andrew Lo of which the FT’s Chief Markets Commentator, John Authers said “his insights should allow investors and regulators alike to manage risks better.”
Austyn Smith is a leading advocate of the ‘risk managed’ approach and ‘all weather’ investing, and has been featured as a Citywire ‘Cover Star’ in 2010, 2013 and 2017.
Following his work on risk reduction strategies, in 2011 he was recognized by Citywire Wealth Manager magazine as ‘Being in a position of some influence among your peer group, and likely to take a leading role in setting the investment agenda for UK Private Client managers.’
Austyn has recently contributed to leading publications by Citywire, and the Institute of Directors, and over the years has been quoted in the Sunday Times, Mail on Sunday, The Independent, and Bloomberg Markets.
With over 25 years wealth management experience, Austyn lives with his wife and children, Black Labrador and Springer, in Beaconsfield, Bucks.