Calm During The Market Storm

January 29th, 2016

Brewin Dolphin, one of the 5 Discretionary Fund Managers sitting on the Radcliffe & Co Investment panel, have produced a very good and sensible commentary on current market conditions.

“Brewin Dolphin’s Head of Research Guy Foster gives his views on the outlook for investors after one bank’s analysts hit the headlines with a gloomy forecast for the year ahead.

Calm heads prevail in financial markets, something that you could be forgiven for forgetting after this week’s panic-stricken headlines.

Some bankers have sparked a media furore by publishing a note titled the “Bears have killed Goldilocks.” What they mean is that the Federal Reserve has killed Goldilocks – the fairy tale expression used to describe the ideal economic conditions for the economy in which inflation is not too hot and growth not too cold.

But there is nothing new in its assessment to cause such a “hysterical” call to action. Yes it has been a quite turbulent start to the year on global markets, but calls to “sell everything” are absurd and should be viewed with caution by investors.

The risk of market corrections of 10%, or even more severe falls of 20%, represent the risks inherent in stock-market investing, but which over time have represented the best performing major asset class. You should bear in mind that past performance is not a guide to future performance.

How patience and a cool head could pay off

Of course, those risks should be avoided where possible but more often than not investors in equities know too well that patience and a calm head may pay dividends at times like this.

Investors making rash decisions will benefit the trading desks of the banks that issue such dramatic recommendations. When asked what markets will do John Pierpont Morgan, the father of modern banking, answered “they will fluctuate”, a point made in legendary investor Ben Graham’s famous text The Intelligent Investor. We position our portfolios for the long term, and so make small adjustments as the long-term outlook changes rather than trying to time the entry and exit points to perfection.

Undulations on stock markets are to be expected but not predicted. The best way to prepare for them is to be ready to react to them. One of the most successful fund managers of all time, Peter Lynch, said: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.”

So have recent events changed our view of the world? In our own macro presentation of a year ago, similarly called “The Death of Goldilocks”, we concluded that we saw no signs of inflation springing back to life, and that global growth conditions had not markedly deteriorated. So no, they haven’t.

For every bearish banker who predicts that the Federal Reserve (Fed) will have to cut interest rates there are still plenty who believe the Fed is in danger of raising rates too slowly.

China casts a shadow, but UK outlook improving

The latest catalyst for panic has been a fall in the Chinese exchange rate – a devaluation. Not because it is a big devaluation – the renminbi (RMB) has only really fallen against the dollar; it appreciated against the pound over the last six months – but rather an unusual devaluation.

The decline in the RMB reflects a movement of capital rather than a weakness of trade. While the size is uncertain, what is known is that China’s trade balance is at record levels and her share of global exports are at their peak, implying a currency which is fundamentally strong.

For the past two decades or more China has held its exchange rate within a tight band relative to the dollar even while sometimes allowing it to gently appreciate over time. People felt this was a one-way bet – that the renminbi would appreciate more as it became more accessible to overseas investors.

We held the opposite view, that the gradual liberalisation of China’s capital account (meaning its currency has become more interchangeable with other currencies) would enable trapped savings to leave.

Once those flows have been exhausted, however, China will be left with a substantial trade surplus – the hallmark of a strong currency. After all, as the currency weakens in the short term, it will boost China’s export performance, which will provide support for the renminbi in the coming months.

The US is another source of anxiety as there has been a softening of economic data over the last few weeks. It is concentrated in the manufacturing sector, which makes up a relatively small part of the economy. This should be set against December’s creation of 292,000 new jobs (source: US Department of Labor) in the US that shows the economy is not collapsing.

UK interest rates

Beyond the US and China we are seeing better economic performances at home, in Europe and in Japan. The UK domestic economy is not perfect and interest rate increase expectations may well be too aggressive; in fact, I do not foresee any interest-rate rises at all in 2016. Rate rises in the UK are likely to be pushed further ahead until wage growth relieves the pressure on highly indebted households. In fact, the one rationale for raising rates would be to slow the inexorable rise of private sector debt and stop stoking prices within an under-supplied housing market. Policymakers, however, seem happy to use fiscal and regulatory tools to address such issues.”