From the beginning of October through to the end of 2018 global equity markets went from drama to pantomime and, in the final fortnight of the year, to farce. The week before Christmas was the worst single week in world markets since 2008 and the last quarter of the year saw the worst equity market performance for over 60 years. Not one of the global stock-markets ended the year in profit. Indeed, the majority were severe double-digits in the red.
As stated in our November report we felt that, in the short term, there was an equally balanced chance that the stock-markets might re-test their recent lows again before a more substantive and lasting recovery and that is exactly what happened. Whilst the first two weeks of December were relatively benign, equity valuations returned to the frenzied and unfocused mark-downs seen in October. When one sees an index being degraded by 6% (with individual company valuations being reduced by 10% or more) in a single day it is a clear sign that the market has temporarily lost touch with economic reality. Trading in these market conditions would be no better than guesswork and so we held (or built) our positions and kept our patience. It does not pay to panic but, conversely, it is rewarding in the longer term to control and manage the understandable fear that such wild market conditions can sometimes generate.
In the last two weeks of December equity valuations were relentlessly hammered downwards regardless of the individual company’s strength. By the Christmas break, stock prices generally had reached levels that suggested bankruptcy risk. In November we gave you a comprehensive list of our investment holdings and their up-to-date financial positions. It was and still is clear from those figures that the companies we are invested in are not liquidation prospects and are far from being on the road to ruin.
Our fundamental aim has always been to “be in the right sectors of the right markets at the right time”. Of course, to a degree that is an idealistic aim; markets are dynamic and today’s ‘best sector’ can become tomorrow’s also-rans. We therefore keep this situation under regular observation by running a quarterly check on all global markets in order to identify those sectors that are regressing and uncover those sectors that are upwardly mobile. Given the performance of market sectors over the past three years, it is hardly a surprise that we are invested as we are…….our holdings have indeed been the ‘best of the best”. Perversely, these have also been the hardest hit by the mark-down in valuations since the start of October.
In our considered opinion this is a passing correction based more on political influences rather than economics.
On 31st December 2018 the FTSE100 index closed the month at 6733.97.24, a fall of -3.61% in December itself and it now stands down at -12.48% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a fall of -12.04% for the month and the Fund is now down -21.56% for the 2018 year to date.
As far as future performance is concerned we still feel that the FAANGS have some way to run. For example, Apple still has more cash in hand than the US government but, sadly, the financial media, in its unseemly haste to specifically criticise that company, tends to mis-report Apple’s message. Apple’s CEO stated very clearly about 6 months ago that Apple would now be focused on selling fewer iPhones but at higher prices and their third quarter 2018 results prove that they have succeeded thus far in that strategy. It hasn’t stopped the knockers from repeating the mantra that Apple is failing because it is selling fewer phones!
However, Apple is no longer just focused on iPhones; it is steadily improving in the lucrative music streaming market (it currently has 30 million subscribers) and is moving into TV. This tends to be ignored or go unreported by the relentlessly negative narrative preferred by the usual suspects.
On the first trading day of the New Year, Tim Cook (Apple’s CEO) gave fair warning that sales in the last quarter of 2018 had been lower than expected (citing the recent short-term strength of the US dollar and the impact of the putative trade war with China) and that revenues for the 4th quarter were now anticipated to be $84 billion as opposed to the previous estimate of $91 billion. Naturally, the market took a negative view of that but it is worth noting that on the two previous occasions that Apple has made such a lower earnings statement the actual numbers then proved to be higher that their guidance figure and were therefore a positive surprise (prompting its share price to soar again). Apple’s actual results will be issued on 29th January and we will, of course, be watching them very closely.
Personally, I am not a fan of Facebook and certainly not an admirer or supporter of its CEO (Mark Zuckerberg) but there is no doubt that the company has been a cash cow and, despite its detractors, it seems set to continue to generate high revenues and profits in the foreseeable future.
Amazon and Netflix are also dominant in their fields and are still just scratching the surface of potential future profitability whilst Google dwarfs the search engine field.
These companies remain largely well-managed, well-motivated and profitable. If and when we detect signs of commercial weakness then we will reduce/remove our investments in any of these organisations. At the moment though they are still flying high despite the current downgrading of their share prices.
Likewise, the same philosophy will guide our actions in respect of our other current holdings and if we detect any potential up and coming areas to more profitably invest in then we will change horses.
On the other side of that coin and as an example of the dysfunctional nature of the last quarter’s market movements, shares in Tesla (a company that has a potentially first class product but has a history of voraciously eating its way through working capital and has yet to turn a profit) have been upgraded over the last quarter whilst established and profitable companies have been substantially marked downwards. How strange to see that on the first trading day of the New Year Tesla’s shares have suddenly and substantially plunged!
As mentioned in our October report, there is no obvious or logical economic basis for this severe downgrading in equity prices and we felt that ‘behind the scenes’ political issues were the more likely proximate cause. No doubt the perspective of time will ,in due course, shed greater light on that. In the meantime, in spite of the Armageddon-like tone adopted by much of the ‘serious’ financial media, there are still positives to be found in the financial results from large swathes of the real corporate world.
In the USA, unemployment continues to fall and now stands at just 3.7% (which is getting close to a level regarded as ‘full employment’). Consumer spending is buoyant, inflation is under control at 2.2% (having been 2.9% a year ago) and US GDP is running at an annualised rate of 3.4%.
By contrast, UK GDP for the 2018 year is expected to be running at 1.5% whilst the self-congratulatory Eurozone (despite benefitting from substantial quantative easing) is only on a par with that.
China’s industrial production has fallen to 5.4% (from an expectation of 5.9%) and its retail sales figures (a reflection of consumer spending and consumer confidence) stand at 8.1% (down from an estimate of 8.8%). These lower than anticipated numbers may well be an illustration of the impact on China of the US trade tariffs imposed earlier in 2018.
On that note, there had been news at the start of December of a thawing in trade relations between China and the USA with both parties expressing keen-ness to structure an equitable free trade deal. Indeed, this caused global markets to have an immediate and very positive reaction. However, the media then chose to wilfully misreport a short series of communications from the US side and this upturn in equities was quickly reversed. However, on New Year’s Eve the US issued a statement to say that there had been substantial and constructive progress towards a comprehensive trade deal and, if this indeed proves to be the case, then it would provide a very positive and sustainable boost to global (and particularly US) equities.
At its mid-December meeting the Federal Reserve, as expected, did increase US interest rates by another 0.25% (taking them up from 2.25% to 2.50%). However, the Fed chairman made much more dovish comments about the direction of future interest rate policy and made reference to just 2 increases next year rather than the 3 that had been anticipated.
Controlling inflation is one of the Federal Reserve’s main functions and maximising employment is the other. In the knowledge that US inflation had fallen from 2.9% down to 2.2% by the end of 2018 and US unemployment has also fallen to just 3.7% there is a strong argument to suggest that the Fed will leave rates untouched through 2019 (and perhaps should have left rates at lower levels earlier in 2018 too). In fact, the Fed Yield Gauge now points towards a cut in interest rates by the first quarter of 2020 if not earlier. Certainly there is substantial political pressure for that to be the case sooner rather than later and any sign of a slower/lower pace of interest rate policy will be good for equity markets.
A lot of hot air was expended last year in relation to the yields on 10 year US Treasury Bonds (the US version of gilts). In comparing the relative attractiveness of Bonds v Equities the most common measure used is the return on 10 year US treasuries. If the yield on these bonds goes above 3% then (to some investors) bonds become more attractive and they will exit the stock-market in favour of obtaining that yield. In fact the 10 year yield did climb to as high as 3.30% at one stage last year but this was not the cause of a mad dash out of the stock-market. Those who were predicting disaster for equities when the 10 year yield did reach that 3.30% level are strangely quiet now that the yield has fallen again to just 2.70%. Another indication of the bias and politically motivated influences that have dogged equity markets over the past three months. Project Fear is alive and kicking in the USA too.
The 2018 fourth quarter reporting season will begin next week and in the course of January we will see the latest financial figures from our corporate holdings. Overall, we expect these numbers to be a continuation of the positive returns seen throughout 2018 and, if that is the case, then they should motivate a much more upbeat and progressive revaluation of those companies whose equity valuations have been most badly affected by the October-December downturn.
From the beginning of October through to the end of 2018 global equity markets went from drama to pantomime and, in the final fortnight of the year, to farce. The week before Christmas was the worst single week in world markets since 2008 and the last quarter of the year saw the worst equity market performance for over 60 years. Not one of the global stock-markets ended the year in profit. Indeed, the majority were severe double-digits in the red.
The counter-intuitive frenzy of downward pressure on equity prices which had begun early in October continued to infect global stockmarkets throughout much of November too. The 2018 year has not been particularly positive for UK, Far Eastern and European equities and at the end of September only the American markets (the Nasdaq and the S&P500) were in profit for the year. However, they were then the hardest hit by this latest correction. At one point during November we noted that of the preceeding 37 trading days, 24 of them had been deeply negative whilst the remaining 13 days had been only modestly positive.
As illustrated in our October report, there was no logical economic basis for this severe downgrading and we felt that the hidden hand of politics was the more likely proximate cause. Indeed, the last time global markets suffered this type of chaotic markdown was during the first month of 2016 when over 20% was wiped off stock valuations. Much later, it emerged that the source of that short period of mayhem could be found in China (where local rules allow for gross over-leveraging by Chinese investors) when investors on the wrong side of what began as a typical small correction were unable to meet margin calls and so were being forced to exit their positions in a hurry. That situation inevitably creates a domino effect.
In the absence of any negative economic evidence to justify the October/November downgrades, it crossed our minds that the root cause of this (much as it was in 2016) might also be found in China and be political in nature rather than economic. It is clear that the additional tariffs imposed by Trump on China/US trade earlier this year have already had a severely detrimental effect on the Chinese economy and, in line with his usual approach to negotiations, Trump has been threatening even more punitive measures. The Chinese, on the other hand, are fully aware of the enormous scale of their investments in US companies and the market-moving power their huge shareholdings give them.
As a communist based managed economy, the Chinese are perfectly used to manipulating exchange rates to their own trade advantage and it is only a small step from there to manipulating stockmarkets in a tit-for-tat response to tariffs. As we approach the latest deadline for the implementation of yet more tariffs, it is conceivable that political activity in China could have been behind this recent downturn.
So much for an overview of the fundamentals; now a little glance from a technical viewpoint.
Whilst the economy’s fundamentals determine the stock market’s medium/long term outlook, technical analysis can help in taking a view on the stock market’s short/medium term outlook. At Quotidian we focus on the medium and long term but for the purpose of this report let’s take a look from the long term, to the medium term, to the short term.
The following comments are all based on the US economy and US markets and so are a realistic proxy for global markets (which invariably play “follow-my-leader” with the US).
Our long-term outlook remains bullish. This bull market will probably last until Q2 2019 at least, after which there could possibly be a downturn. As we have shown in the past, if a real (rather than an artificial) downturn presents itself then we are perfectly happy to revert to cash until the storm passes. We see the current stock-market situation as a synthetic markdown and (in light of so many positive company results for the 3rd quarter) we are prepared to hold our nerve. In our view it would be entirely wrong to panic and sell out and, in so doing, turn a temporary paper devaluation into an actual financial loss.
The economy and the stock market both move in the same direction in the long term, hence leading economic indicators are also long-term leading stock-market indicators. Most leading indicators are still improving. However, the US economy is getting close to “as good as it gets” which suggests that it may start to deteriorate later in 2019.
Our medium term outlook (next 6-9 months) remains bullish.
Our short-term (1 to 2 month) forward view suggests there is a 50% chance that the stock market will pullback again before heading higher but, in our considered opinion, head higher it will to reflect the economic reality of demonstrably positive corporate performance.
So this is where we believe we are right now:
We’ve seen the substantial downwards correction in October and November; we had the typical 60% retracement (upwards bounce) in the first three or four trading days of November and since then we’ve suffered the re-visitation downwards to retest the recent lows. In the final week of November we had a very positive upwards movement again and this is exactly where we stand today.
We believe that markets are now on the way back up (but there is an equal chance that we may re-test the recent lows again before a more substantive and lasting recovery). The fundamentals are positive and on our side; the technicals are evenly poised but we think more likely than not to be biased in our favour too. Isn’t it strange how these patterns tend to repeat themselves; they are not entirely infallible but recognisable nevertheless.
An investor is always best advised to focus on the medium term and the long term. Short term judgements are in danger of being too greatly influenced by emotion and decisions taken when under the influence of fear can very often be poor ones.
Whilst writing this (on Sunday 2nd December), breaking news from the G20 meeting currently taking place in Argentina suggests that there has been a rapprochement between the USA and China on trade talks. The threat of further tariffs being imposed on 1st January has now been removed and it would seem that all is now sweetness and light. It will be very interesting to see how equity markets respond to this news. If stock-markets now turn quickly upwards again on the back of this trade breakthrough then that would add credence to the theory expressed above in respect of the underlying cause of this period of market negativity.
As I’m sure you are already aware, October has been a dismal month in global stock-markets.
You will, of course, have seen the carnage in equity markets all around the world over the past three weeks with days of very severe price mark-downs occasionally interspersed with similarly large upswings. Overall, though, the general trend has been profoundly negative. Naturally, Quotidian’s performance has been adversely affected in the same way as the market and all other equity-based funds.
On 31st October 2018 the FTSE100 index closed the month at 7128.10, a fall of -5.09% in October itself and it now stands down at -7.28% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a fall of –15.28% for the month and the Fund is now down -6.06% for the 2018 year to date.
We have seen this sort of remarkable volatility and tumultuous price-action many times before; it is an inherent feature of equity markets and a regular occurrence. It can, indeed, be unnerving whilst it’s happening but valuations inevitably recover. Earlier this year equity markets went through a 10% correction late in January and had recovered in full by 26th February. Similarly, in just the first few trading days of 2016 markets suffered a 20% correction but had recovered to their previous highs by 6thApril that year.
At times of such excessive and relentless turmoil it is always worth revisiting and reminding oneself of the basic principles of equity investment. Fundamentally, equity valuations and pricing are a reflection of a company’s current profitability, its prospect of future profitable growth and the relationship between the demand for and the supply of its shares.
Valuations can be and are affected by non-economic considerations but nothing particularly fresh in terms of political news has emerged that would cause real panic to disturb and distress stock-markets. Markets have known for quite some time about the potential economic effects of Brexit (and, on balance, we believe these to be much more positive than negative), and the Italian budget issue with its potential knock-on effects on the Eurozone has been well reported. The threat of trade wars is old hat as is the existence of substantial sovereign debt. All are well-worn, repetitive and tired excuses for negativity.
With that in mind, the speed, severity and indiscriminate nature of the price mark-downs suggests to us that much of this correction is synthetic.
On the subject of putative trade wars we have already seen positive results achieved between the USA and Japan, South Korea, Canada and Mexico all through the use of Trump’s standard tactics. A new and balanced trade deal will ultimately be achieved between China and the USA too after the necessary face-saving preliminaries have been duly observed. It has been obvious for many years that China has regularly manipulated its currency in order to make the prices of its exports to the US attractive. This blatant curreny manipulation continues to this day; it must be simply coincidence that in the six moths since Trump first imposed higher tariffs on Chinese goods the yuan has depreciated in value by 10% against the US dollar. How remarkably strange that this is exactly the same level as the initial round of tariffs.
Expanding upon the current market turbulence, just consider these points:
- As an illustration of the recent stock-market climate, on 23rd October the Nasdaq index opened flat but then dropped by over 3% in less than half an hour. By close, however, it had recovered to finish just marginally down. That incredible volatility cannot possibly relate to economic reality or individual company prosperity. It is symptomatic of the current absurdity.
- One of the companies we invest in issued a new product on 19th. It was well received but one analyst took the first three days sales figures and extrapolated those three days (two of which were Saturday and Sunday) to produce a ‘serious’ report which concluded that annual sales would be disappointing and thus justified downgrading the shares. At best we would suggest that this is implausible and no better than guesswork (or an analyst trying to make a name for himself) and at worst this is breathtaking idiocy. Sadly, this is also symtomatic of temporary periods of market myopia.
- In the first week of October, official figures were released showing that the US economy had expanded at an annualised rate of 4.2%. In itself that is an extraordinary level of economic growth and, when compared to global rates of growth, this is stellar. Taken with other economic indicators it also gives every reason to suggest sustainable growth in the USA.
- The Federal Reserve (the Fed) has been increasing US interest rates from a position of strength not as a reflection of economic panic and these increases are at a snail’s pace so as not to spook the equity markets. An age-old economic adage holds that when money supply tightens (that is, when it becomes more difficult and more epensive to borrow money) then stock-markets tend to plateau or gently decline; but that does not infer falling over a cliff. It may be that the Fed has pushed interest rates higher at too fast a pace but striking a balance between maintaining economic growth whilst also controlling future inflation is fraught with difficulty and the results of their current policies will not become clear for a year or two. Either way it doesn’t satisfactorily explain the recent mayhem. Yes, the 10 year US Treasury yield has just slipped slightly above 3% and this will cause some investors to switch from equities into bonds but we’re not talking here of a mass exodus.
- In recent years there has been an exponential growth in the use of computer-activated trading based upon man-made algorithms (algos). These programs automatically trigger unthinking responses to share price movements (usually on the sell side) and simply create a domino effect which magnifies and aggravates market downturns.
- Closely related to algo-trading is another relatively recent phenomenon known as High Frequency Trading (again, of course, computer driven) which facilitates the placing of huge volumes of trades in timescales measured in micro-seconds. The aim is to create tiny amounts of profit from a sequence of very large trades (both in size and frequency) which may be opened and closed again in a matter of mere seconds. The effect of this method of trading is that it manipulates the market and disorts its real pricing mechanism which always used to simply be based on factual supply and demand. In our view High Frequency Trading amounts to market abuse; we feel that it lacks integrity, is immoral and should be prohibited.
- October was the start of the third quarter earnings season and these earnings and projected future sales figures were expected to be strong…..very strong. Indeed, over half of the asset holdings in our fund have already now reported their figures have all been well above forecasts.
A cynic could take the view that market-makers might be eager to encourage onto their own books a substantial number of shares in ‘obviously profitable companies’ in advance of their earnings releases; and if they can buy those shares at fire-sale prices then so much the better. Creating fear and panic selling would be an obvious way to motivate some investors to dump shares at deeply discounted prices and then those very same market makers will magically cause prices to slowly rise again and thus make a huge profit for themselves. Cynical?….yes. Crazy or paranoia??….No. It’s the reality of the marketplace!
The incredible level of imagination or invention needed to translate positive results numbers into a negative and pessimistic narrative simply in order to justify share price reductions can be quite astonishing.
Fourteen of the 22 individual companies in which we hold shares have now reported their third-quarter results and, without exception, all of these have produced profits (earnings per share) higher than market analyst’s expectations (and six of them have been very much higher!). We anticipate a similar picture as the remaining companies in our portfolio release their figures too. The indiscriminate marking down of their share prices should therefore be a temporary (but typical) market blip.
We haven’t sold anything and so we haven’t consolidated a temporary paper price-cut into an actual financial loss. Quite the reverse in fact; instead, we’ve been topping up a number of our holdings at bargain basement prices and in the longer term that is a winning philosophy.
We anticipate that their temporary market prices will turn again to reflect their intrinsic maket value before too very long. We also remain entirely confident in the constituent parts of our portfolio. If and when that confidence changes then we change the relevant holding in the fund.
The best way forward is to keep one’s head, keep emotions in check and let the current madness pass.
As a final thought to reflect on. On 4thOctober our oldest and longest-standing client was called to join the heavenly choir. He would have reached the age of 90 next month and has been a Quotidian investor for nearly 30 years. It is both poignant and relevant to recall his reaction to the many and typical points of turmoil in the stock-market cycle over that period of time.
Whenever equity markets hit turbulence or went through a period of correction he would be the first to telephone and the conversation was always exactly the same: “Courage, mon brave; we all know that markets correct once in a while; I trust you implicitly and I’m happy to leave it to you to get on with managing it through; it’s always reassuring to know that the pilots are in the plane too.” That situation remains the same; our own capital sits alongside yours in the Fund and is subject to exactly the same same investment performance.
We salute his intelligence and grieve his passing.
More often that not the final quarter of the year tends to be the most productive and profitable from an equity investment viewpoint. Perversely, September has a relatively poor historical record of stock market performance. Of course, these comments are generalisations based on bygone records and I can find no cogent or logical reasons to explain this phenomenon. The best I can come up with is that the markets pause for breath in September in order to prepare themselves for the anticipated final quarter uplift.
Having said that, with the exception of the US markets global equities have largely been under a cloud for 2018 thus far. In particular, the UK stockmarket has been hobbled by the ongoing grind of Brexit negotiations.
In his pretentiously entitled ‘State of the Nation’ speech this month (and with no hint of irony) Jean-Claude Juncker declared that over the next ten years the Euro will become the global currency of choice. With a sense of bravado bordering on idiocy he seriously asserted that a currency unlikely to still exist in 10 years’ time will usurp the US dollar as the world’s predominant reserve currency. Group-think bubble or blowing bubbles?
If nothing else, it casts a ray of illumination onto the inner workings of the EU and the delusions of grandeur that permeate its upper echelons of power. The Euro was hastily cobbled together and prematurely introduced towards the end of 1995. Using the EU’s own data, in 1999 it accounted for 20% of global currency reserves. By 2004 it was close to 25% of the world’s reserves but by 2017 it had fallen back to 19.90% again.
Indeed, since 2009 it has fallen 3% and continues to fall as a percentage of global reserves; but why let the EU’s habitual and typically inelegant variation of the facts interfere with hubris. Hubris, of course, is often rapidly followed by nemesis; there is more chance of the Monopoly money issued by the Reserve Bank of Toytown ever becoming the world’s reserve currency.
Juncker was shown on television earlier this month literally staggering and stumbling from one meeting to the next (needing a man on either side to hold him upright). Following that remarkable episode the EU felt the need to issue a statement explaining that J-CJ apparently suffers from bouts of sciatica. Unkind commentators have suggested that these bouts occur in direct proportion to his consumption of champagne.
Whilst Brexit continues its weary path towards March 2019 the UK equity market will remain in thrall to Juncker and his merry men.
On 3oth September 2018 the FTSE100 index closed the month at 7432.42, a rise of +1.33% in August and it now stands at -2.03% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of+1.08% for the month of August and the Fund is now up +10.88% for the 2018 year to date.
Since 1972 there have been 48 referendums on the EU by a variety of its member states. It is an interesting and revealing fact that every one of those that went against the EU was re-run “until the electorate gave the right answer”.
With that as the background, the EU’s strategy in relation to Brexit has been simply to try to force a second referendum. It’s tactics in that aim have been to deliberately obstruct and frustrate progress towards an equitable settlement, to create and focus on synthetic ‘problems’ in order to divert attention away from real issues and generally to waste time as a means of arriving at an artificial cliff edge. All this has been accompanied by over-emotional jargon designed simply to engender fear as opposed to using more pragmatic language to better explain and clarify the pros and cons of the UK’s decision to leave the EU project.
Simultaneously and with increasing vigour, the EU and its gang of ‘useful idiots’ (viz. the Governor of the Bank of England, the head of the IMF, committed high net worth remainers and swathes of the visual, aural and written media) has choreographed a constant drip of negative propaganda liberally laced with disinformation and threats. These seeds of doubt are intended to sap our will to continue by creating the impression that escape from the EU would be too difficult, too expensive and not worth the effort. Exactly the same tactics were used in the past to overurn the democratic anti-EU referendums referred to earlier in this piece (particularly those in Denmark, in Ireland and in France); they worked then and the EU believes that they will work now.
In another sphere, but equally important from an economic viewpoint, on 25thSeptember the EU proposed a new payments system (a European Monetary Fund) designed purely and simply as a device to circumvent and attempt to wreck the sanctions that the US has imposed upon Iran. It is generally accepted that Iran is the leading sponsor of terrorism in the Middle East and further afield. Towards the end of his tenure, Obama’s removal of sanctions on Iran in return for a worthless promise to de-nuclearise was one of his ‘signature’ deals. Iran was given renewed access to £100bn which was promptly used to develop its nuclear strength. At best Obama was naïve and at worst he was reckless and made the world a more dangerous place.
The EU’s new payment system and its dubious intent sends a very clear message that Europe will plumb any depths in order to save its trading relationships with Iran regardless of the wider risks. In so doing it illustrates clearly that the EU sees financial protectionism as more important than the cost in human lives.
Despite the EU’s typical back-stabbing and underhandedness (and in spite of the sniping and negative comment that he attracts from those areas of the media that would prefer to see him fail) Trump’s economic successes continue to accumulate. Having terminated the North America Free Trade Agreement earlier this year (an unbalanced trade agreement involving Mexico, Canada and the USA which was created by his economically myopic predecessor), a new and fairer (to both sides) trade deal was agreed between the US and Mexico. Negotiations are continuing with Canada to include it in the new pact and I have little doubt that Canada too will join this fresh and equitable trade pact later this year.
Shortly after taking office, Trump also withdrew from the Trans-Pacific trade treaty (TPT) set up by the previous US regime. It was announced on 27th September that Japan and the USA will now open negotiations on a bilateral trade agreement between the world’s first- and third-largest economies. This represents a significant change of attitude by Japan (a change which may have some marginal connection with Trump’s threat to impose punitive tariffs on Japan’s motor car exports to the US. The world is now entirely familiar with Trump’s tactics and (given the huge importance of the American consumer to world trade) there is no doubt that they work. A realistic new trade deal will now be struck and one could reasonably conclude that the positive end justifies the means.
This month also witnessed news that South Korea and North Korea are preparing to enter into a trade agreement (unthinkable until very recently and a rapprochement that was instigated by President Trump).
From an investment perspective August has historically been a slow, tedious and dismal month featuring very low volumes of equity trading which leave stock-markets open to volatile intraday movements and day to day see-saw action. This year has been no different.
In theory, of course, equity prices should reflect a company’s current profitability and its prospect of future growth in profits. In practice, however, prices can be manipulated to reflect market-makers’ interpretations of political events (or natural disasters) and so, particularly during periods of low activity, share valuations can fluctuate wildly day by day. Ultimately though, economic fundamentals will reassert themselves and shares prices will reflect the laws of supply and demand.
One of the skills of investment management, therefore, is to recognise the difference between share prices based on the emotional interpretation, corporate opinion and financial self-interest of market-makers as opposed to prices that reflect economic reality.
On 31st August 2018 the FTSE100 index closed the month at 7432.42, a fall of-4.08% in August and it now stands at -3.32% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +3.63% for the month of August and the Fund is now up +9.84% for the 2018 year to date.
I have attached to my covering email a screen shot of the 2ndquarter results for all our current holdings. You will see from this that we presently hold shares in 22 individual companies. Of these, 21 have produced figures that are ‘positive surprises’ (being above market expectations) and only 1 which marginally missed its estimates. As markets returned to normal volumes of trading in the last week of August that positivity has been reflected in their share valuations.
During August the problems in Turkey’s economy have become even clearer and it is obvious that these issues have developed as a result of persistently inept financial management from its ego-driven President Erdogan.
The Turkish lira has fallen in value by very nearly 40% this year to date vis-à-vis the US dollar. This should make its exports more attractive to the US market but Turkey and the United States have been embroiled in a fractious dispute focused on an American preacher who faces being tried on terrorism charges in Turkey. Diplomacy has failed to achieve an equitable resolution.
Never one to miss an opportunity to gain a negotiating advantage by kicking a man when he’s down, President Trump has therefore stymied that potential area of financial relief by doubling the tariffs on Turkish exports arriving into America. It gives a new, fuller and more profound meaning to the phrase ‘being trumped up’.
The wider economic implications relate to the flawed currency that is the Euro. European banks areup to their necks in Turkish debts; Italian banks are exposed to Turkish liabilities to the tune of $17 billion; French banks: $38 billion and Spanish banks: $83 billion. Whilst I do not have relevant figures for German banks I have no doubt that their numbers would also show a worrying degree of exposure to Turkey’s indebtedness.
The Lira’s collapse may be forewarning an implosion in Turkey’s economy as a whole and its debt structure too which, in turn, is already creating substantial money inflows to the United States and stress-testing the Eurozone’s viability to withstand Turkey’s potential default.
However, Italy poses an even greater threat to the Eurozone’s stability. The European Central Bank will be reducing its Quantitative Easing (‘QE’) programme by half in October as a precursor to ending QE altogether on 31stDecember. From 2019 onwards there will no longer be a lender of the last resort in the Eurozone.
The Italian government has promised to effect fiscal expansion equivalent to 6% of Gross Domestic Product (‘GDP’). The EU, though, wants to impose fiscal austerity and budgetary control upon Italy but, with a large degree of justification, the Italian government will not accept that. Italy is not the economic basket case it has historically sometimes appeared to be; it still comprises the EU’s second largest concentration of manufacturing industry and it has a current account surplus of 2.8% of GDP. Italy is also a net positive contributor to the EU and, whilst its sovereign debt now stands at 132% of GDP (which is an area of vulnerability), it would only risk insolvency because the EU will no longer have a lender of the last resort from 1stJanuary 2019.
Thereafter, any bailout would require the backing of the European Stability Mechanism (‘ESM’) and, as we saw with Greece, the ESM imposes profoundly stringent terms and conditions designed essentially to protect German banks from their own bad debts and to beggar (I think that’s the correct spelling) the ‘offending’ country.
Italy would certainly not accept the draconian terms forced upon Greece and it has already put in place a parallel currency which could be introduced to replace the Euro. If this were to happen (and the new Italian government gives every indication that they are prepared to act assertively) then the structural flaws in the Eurozone would be exposed yet again and Italy’s parallel currency would subvert monetary union from within.
Italy plans to rebuild its dated infrastructure (and the disastrous collapse of a road bridge in Genoa last week provided stark evidence of the pressing need for that) without budgetary constraints.
The Italian government has cited “The Golden Rule” as its means of funding the expenditure it intends to make on renewing infrastructure. In this sense the ‘Golden Rule’ was a device instigated by the slippery, one-eyed and wanton Gordon Brown (once the UK’s financially incontinent Chancellor) and which, by dubious mathematical sleight of hand, excludes public expenditure from the national budget deficit.
Those of us of a certain age will recall a somewhat different definition of The Golden Rule: “Those who have the gold make the rules”. In the EU’s case, Germany has the gold and the control over it. A trial of strength is looming therefore between Italy and its new government (which, for a refreshing change, has not been imposed by the EU and therefore does not contain EU supporting placemen) and the Brussels/Berlin axis; a test of will which could bring down the fragile Eurozone banking system (and cost Germany around 2 trillion euros in loan defaults). Interesting times.
The latest in the Brexit saga has been the EU’s assertion that British intelligence has been bugging EU working party meetings and had thus penetrated the inner circle of the EU’s negotiators. By coincidence this revelation came on the very same day that Theresa May was meeting with Angela Merkel in a ‘hastily arranged’ attempt to sell her anaemic ‘Chequers’ plan. When it comes to negotiation and salesmanship (or indeed any social interaction) miscast May resembles the stiffness of a poker but contrives to radiate nothing even of its occasional warmth.
In light of the problems now facing the EU from both Turkey and Italy, any UK negotiator worth their salt would now use the blunt instrument of time to put pressure onto the EU. Despite its arrogant and aggressive approach, the EU needs a workable Brexit arrangement far more than the UK does. A Brexit deal should therefore be ‘kept on the long finger’ (as they say in Ireland when they mean ‘kept waiting’ or ‘deferred’) to avoid making any agreement until the challenges posed to the EU by Turkey and Italy have played out.
The shabby Brexit letter issued by Toothless Theresa in mid-August is yet a further salvo in Project Fear and is shameless in its negativity, mendacity and bias. When the UK needs the Iron Lady what it has is Polythene Pam; the weak-willed Myopic May who now lacks even a scintilla of credibility. In the season of A-Level and GCSE results her tawdry missive earns an A* in the Art of Deception. Worse still she is backed up by Fireman Sam, the half-hearted, hapless Hammond who is doing his utmost to hinder progress towards successful Brexit negotiations.
Taxes paid by the 26.7 million people working in the UK’s private sector pay for the salaries, pensions and expenses of the 5.4 million people employed in the public sector (teachers, police, firemen, doctors and nurses, politicians and civil servants). That being so, is it too much to ask our civil servants (the clue is in the name) and politicians to respect democracy and give effect to the majority view rather than pursue their own personal wishes, opinions and agendas.
The main issues of investment significance this month have both emanated from the United States; one reflects positive corporate strength and the other signals economic vigour.
As I write, the second quarter reporting season is in full swing and, to date, 245 of the companies that comprise the S&P index have reported their latest results. Of these, 216 (88.9%) have issued positive earnings numbers that are well ahead of analyst’s estimates and 180 (73.5%) have also produced higher than expected sales figures.
In addition to these wide-spread corporate successes the latest statement on US Gross Domestic Product (GDP) was released on 27th July and showed that the US economy had increased at an annualised rate of 4.1 percent in the April-June quarter. The same statement also revealed that the US trade deficit had fallen by $52 billion; quite an achievement.
These exceptional figures come as a direct result of the Trump administration’s tax cuts together with their repealing of substantial layers of petty-fogging regulation put in place by the Obama administration and which had hobbled US business activity. The US government’s actions have rejuvenated consumer confidence, boosted consumer spending and improved business investment. However, in the eyes of large parts of the media Trump can still do nothing right.
Perversely, the US stock-market (and particularly the tech sector) had a severe four day sell-off on the back of these remarkable numbers. The rationale offered by market-makers was that these results were backward looking (ie. historical) whereas sales (and therefore potential profit) projections were forward looking. To a degree that is true but, for the moment, it’s a pretty limp response to demonstrably positive economic progress.
Market commentators also offered the opinion that the rise in GDP could not be sustained (which is entirely conjecture and contrary to the US Treasury’s guidance statement for the foreseeable future). The real facts will emerge in due course and equity valuations will eventually have to reflect the actuality.
Facebook (a company that is hard to like from an ethical viewpoint but, from an investment stance, is a huge cash generating machine) was chosen for special treatment when it was one of the minority to miss its estimated earnings level. Its shares were marked down by just over 20% in a matter of minutes as the market digested its results. The Quotidian Fund has a holding in Facebook and this mark down alone caused the Fund’s year to date profit to fall by just under 1%. However, the tech sector generally was also heavily marked down across the board. We took the opportunity to increase a number of our holdings at a remarkably low prices in the expectation that this gross over-reaction will correct itself over the next few months. If we are wrong then we’ll seek to extract ourselves before any real damage can be done.
Trump’s negotiation tactics continue to pay dividends. His threat to impose further tariffs on trade between the US and the EU (and specifically to introduce substantial new duties on automobiles) caused both Merkel and Juncker to rush to Washington to plead for a rethink. Of course, the media will not project the velocity of the EU’s rattled and urgent response in that way. Strange, though, how the EU reacts so swiftly and with a show of reasonableness when the boot is on the other foot and they are not in control of the situation.
Trump is fully aware that this could be a knockout punch to the German economy and also to the entire European Union farrago because it threatens to:
- cause widespread layoffs and unemployment not only in the German automobile industry but also in the many subsidiary industries that feed its auto assembly lines
- thereby create a new budget crisis in Europe’s richest country
- potentially precipitate a collapse in the euro
- and further reduce, or even remove, any vestiges of political support for the old guard-defenders of the failing EU experiment (and, in particular, Angela Merkel).
Naturally, Merkel and Juncker are equally aware of the impending disaster if Trump’s motor tariff threats become reality and are seeking to delay or remove that possibility. It appears that Trump has now agreed to delay implementation for the time being whilst further talks on a revised trade deal take place. There is no doubt about who will be holding the whip hand in those talks.
Meanwhile, Muddling May continues on a painfully slow path towards her latest version of Brexit, although her latest iteration comes nowhere near the Brexit that the majority of the UK voted for. Of course, we have become used to deceitful politicians but it still comes as a shock when her duplicity, deviousness and mendacity is so blatant. Hopefully the EU will still refuse to accept this latest deal it in the expectation that they can force her to even greater give-aways. Perhaps we can then walk away and revert to World Trade Organisation rules for ongoing trade with the EU whilst building profitable new trade deals around the world with trading partners who are not blinkered by self-interest, protectionism and left wing ideology.
The UK stock-market remains in the doldrums whilst Midshipman May fails miserably in her navigation and steerage. If only Turgid Theresa could grasp the real meaning of leadership.
On 31st July 2018 the FTSE100 index closed the month at 7748.76, a rise of +1.46% in July and it now stands at +0.79% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a fall of -0.43% for the month of July and the Fund is now exactly +6.00% for the 2018 year to date.
Returning to the theme of tariffs in relation to the automotive industry it is worth noting some numbers which may illustrate the importance of this sector to the overall economy:
|Market||Cars sold in 2017|
Projection of cars to be sold in 2020
These figures make the magnitude very clear of the car manufacturing industry very clear, especially to Germany. Demand in the USA and the EU is set to be static; any additional costs flowing from tariffs on raw materials (eg. steel and aluminium) are likely to make the price of the end product uncompetitive in the expanding Chinese markets.
Global stock-markets were benign to moderately positive for much of June until the last week of the month when prices were subjected to dramatic see-saw action. This was largely based upon exaggerated fears of a potential global trade war which, in our view, is nothing more than media-inspired market noise for the time being.
June 30this, of course, also a quarter-year end and, as such, is the expiry date for a range of futures and options contracts. It is hardly surprising therefore that equity prices fluctuate in the lead up to that. However, short-term equity market downgrades simply create the chance to buy shares at attractive prices and so we took the opportunity to top up our holdings in those companies that we think highly of and that we trust to perform.
In past reports we have highlighted President Trump’s well established negotiating techniques; initially he seeks to intimidate in order to put the other side onto the back foot and focus their attention. This is particularly so when dealing with the Chinese and EU leaders (he doesn’t need to adopt the same tactics with the UK because we don’t currently have one) by using theatrical statements designed simply to bring his target audience to the negotiating table.
Trump’s initial threats of trade tariffs brought a petulant reaction more suited to the primary school playground from the EU followed, without a shred of irony, by ineffectual complaints and reciprocal threats of their own. The fact is that trade between the USA and the EU is carried out under World Trade Organisation rules and has for years been characterised and tainted by EU protectionism and disproportionate tariffs. For example, new cars exported to the US from Europe are subject to just a 2.50% tariff on arrival in the USA and yet new cars entering Europe from the US are penalised with a 10% EU tariff. The list of similar tariff discrepancies in Europe’s favour is a long one. Hypocrisy or arrogance? Either way, Trump is no longer prepared to turn the lazy and complacent blind eye favoured by his predecessor.
Like him or not, Trump has a clear trading strategy and knows how to play his negotiation cards. The aces up his sleeve are that EU and Chinese manufacturing industries are highly dependent upon the US consumer whereas the US, as the world leader in technology (and which China and the EU are particularly reliant upon) is not nearly as dependent on selling its industrial output to them.
After a period of typically tedious political posturing, the current storm in a teacup is highly likely to blow over soon enough simply because none of the parties involved can afford the dystopian reality of a full-blown trade war. In time, Trump will no doubt achieve his aim of fairer trade between the USA and its main commercial partners and the empty threats of a global trade war will die away again. Stock-markets should then emerge from their torpor.
It is worth noting that the FTSE 100 index has only recently exceeded the peak it reached on 30thDecember 1999. It was then at a reading of 6930 and today it stands at 7636. In other words, it has taken the main UK Index just over 18 years to increase by 10%; roughly equivalent to just 0.55% p.a. Of course, that is a somewhat simplistic measure because it ignores the inherent dividend yield achieved. Over the period, that yield has been running, on average, at 3% per annum and whilst its overall performance has therefore just about kept pace with inflation it is hardly a strong endorsement in favour of passive tracker funds.
The lifeless and unexciting tone of global equity markets continues as we reach the halfway point of 2018. Only two of the world’s stock exchanges are now in positive territory for the year to date as political uncertainty and unsustainable levels of sovereign debt continue to weigh on market confidence. In the UK the stock market still awaits a positive resolution to the monotonous Brexit negotiations whilst in Europe they face additional political, social and economic problems which the EU desperately tries to deflect attention away from.
The eurozone has problems aplenty although you would not necessarily think so from the propaganda flowing out of Brussels. In economic terms, over the eight-year period from 2008 to 2016 the eurozone’s real gross domestic product (GDP) increased by a meagre 3% in total; an average annual growth rate of less than 0.4%. And they trumpet this as success!
Putting that figure into better focus by comparison with US economic performance over the same period; in 2000, just one year after the euro was introduced, the US economy was only 13% larger than that of the eurozone. By 2016, however, it was 26% larger (and it is salutary to note that this significant outperformance has occurred despite the fact that during this period the US economy suffered the bursting of the dot-com bubble, the sub-prime loan catastrophe, the failure of Lehman Brothers and the subsequent banking crisis leading on to the ‘Great Recession’). And now the eurozone economy is faltering badly yet again.
Expanding that theme to some of the largest individual component parts of the EU:
Italy’s new government is refusing to ratify a long-awaited EU free-trade agreement with Canada, a refusal which is threatening to derail the EU’s most ambitious commercial deal thus far and is driving Brussels’ eurocrats to distraction.
To quote Joseph Stiglitz (an Economics Nobel Laureate): “The euro was a system almost designed to fail. The backlash in Italy is another predictable (and predicted) episode in the long saga of a poorly designed currency arrangement in which the dominant power, Germany, impedes the necessary reforms and insists on policies that exacerbate the inherent problems.” Germany, of course, has been the main (arguably the only) beneficiary of the euro construct.
In Germany, durable goods orders have fallen for the fourth consecutive month which clearly signals an economic downturn in Europe’s largest economy. As a consequence, the German Institute for Economic Research has just cut its growth forecast for Germany, partly due to its unexpectedly weak start to 2018 and partly because of the potential financial disaster (in terms of a default on huge German credits) which could ensue from the actions of Italy’s new government. Even a well respected German economist, Claus Vogt, now predicts that “The party in Germany is over.”
Yet despite these obvious signs of weakness (which one would expect to be countered with a stimulus programme) Germany’s finance minister has just announced a further dose of austerity. He wants to reduce investment, cut defence spending and lower the country’s contributions to the EU budget. Brussels is aghast but is powerless to stop him.
Meanwhile, Germany’s anti-EU “Alternative for Germany” (Afd) party continues to gain strength whilst Merkel’s cobbled-together, wishing-and-hoping coalition government (which is held together only with string and sealing-wax) struggles to keep its head above the waterline.
From the latest figures available, Germany runs a current account surplus equivalent to 8.7% of its GDP. According to EU rules, a surplus this large is illegal but it’s strange how the EU’s bureaucrats always seem to find a way around their ‘immutable rules’ when it suits them to (and particularly when it suits Germany).
In simple terms it means that Germany sells to its trading partners far more than it buys from them. Ecomonic theory (or, at least, Keynesian theory) holds that a country with such a huge current account surplus should use it (indeed, has a duty of care to use it) to increase the amount it buys from those countries with a current account defecit and thus kick-start demand in those countries (which in turn will motivate supply and ultimately create profit in what then becomes a virtuous economic circle). The fact that Germany steadfastly refuses to do so could be interpreted as it maintaining a substantial financial buffer in recognition of its own social and economic difficulties.
Trump, of course, is fully aware of Germany’s economic weaknesses, ergo the timing and precision of his threats to introduce tariffs. It is very obvious and commonly held wisdom that, in business or in sport, one seeks to identify the weaknesses of one’s opponent and then exploit them. Trump has focused on German economic weaknesses (and it would be cruel to also mention the travails of their football team so I won’t) which may explain the speed and naivety of the EU’s initial response; he has clearly hit a nerve or two. The bargaining power that Trump now has with the EU (using Germany as a proxy) will, in due course, probably secure the fairer trading terms he has been seeking. He also, quite understandably, reasonably and rightly, wants the EU to pull its weight in terms of financial contributions to the costs of maintaining NATO.
As for Brexit, it is the least of the EU’s worries. EU negotiators are still using time as their blunt instrument in the hope (or expectation) that shortage of time will lead to an abandonment of Brexit altogether or, even better for them, a fudged deal that leaves the UK in thrall to the EU but without a say in any of its policy-making.
Whilst Michel Barnier is the suave face of the EU’s Brexit negotiations (exhibiting all the arrogance and complacency befitting a member of its all-powerful but unelected elite), the real terms of the UK’s departure are set by Germany and, in particular, by a department of the European Commission headed by Martin Selmayr. Selmayr is an honours graduate of the Arthur Scargill School of Charm and has made it his aim to force through a Brexit deal which papers over all the cracks in Germany’s economy at the UK’s expense; a deal that leaves Germany with all the economic advantages and the UK with nothing.
The EU’s unity is crumbling as disagreements over the migrant crisis continue to rumble on and there is an enduring failure to complete new trade agreements (particularly with China, with the USA and now with Canada). In fairness, the UK is not being dealt with any differently from other member states. EU mandarins are nothing if not even-handed; they treat us all with equal contempt!
Whether by accident or design, the timing of Trump’s trade threats is very helpful to the UK. If those in charge of Britain’s end of Brexit negotiations were bold enough to take a leaf from Trump’s strategic approach and assertively exploit Germany’s multiplicity of economic and political weaknesses we might actually see some positive progress towards an acceptable exit deal. That would certainly help to cure the UK stock-market’s current constipation.
Only three of the established equity markets around the world are currently in positive territory for the 2018 year to date and even those three are just marginally above the waterline. Markets have been subdued by a series of political issues whose economic significance has been either invented, misinterpreted or blown out of all proportion.
A great deal of hot air has been expended in respect of a putative trade war between China and the USA. This has been one of the main excuses put forward for lacklustre and volatile equity markets in the first five months of this year.
However, as a guide for the perplexed, one only has to recall Trump’s mantra on the day of his inauguration that his aim was to put ‘America first’.
It has become increasingly clear that trade deals entered into by Trump’s predesessors have been commercially inept from the US viewpoint and those deals agreed in respect of nuclear disarmament and climate change have, at best, been naïve and, at worst, simply reckless.
Those who seek to deride President Trump or diminish his methods and achievements find it all too easy to target his appearance and his negotiation techniques but, in their eagerness to find fault and project him as a figure of fun, they tend to overlook or underestimate his successes.
The current imbalance of trade between China and the US runs to a not insignificant $375 billion in China’s favour. A knock-on effect of that has been to diminish America’s manufacturing industry and marginalise those who were once employed in that sector.
In April, China’s huge telecoms business (ZTE) was proved to be guilty of breaching US trading sanctions against Iran and North Korea and, as a result, it was banned from dealing with any US companies. ZTE provides employment for 70,000 people in China and from mid-April until now this veto has already cost ZTE an estimated $3 billion in lost revenue. Clearly, an extended period of prohibition would create unwelcome economic and social problems for ZTE and the Chinese government (which is its majority shareholder).
Trump has described the Chinese leader (President Xi) as ‘a world class poker player’ and in direct negotiations this month between Trump and Xi it has been agreed that ZTE will accept a fine of $1.3 billion plus a guarantee to buy US components to the tune of $200 billion. The conciliatory tone adopted by both leaders suggests they fully recognise that a trade war would be detrimental to both countries and it would seem that this risk (if indeed it was ever a real risk rather than a negotiation stance) has receeded. Trump, despite his many critics, has ensured that ZTE will stay in business whilst simultaneously eroding substantially, in the short term, the present China/US trade imbalance. In so doing, he has shown himself to be an equally gifted poker player!
On 31st May 2018 the FTSE100 closed the month at 7678.20, a rise of +2.25% in May and it now stands at -0.12% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a profit of +4.68% for the month of May and the Fund is now standing at +4.67% for the 2018 year to date.
As I was putting the finishing touches to the narrative of this report on the penultimate day of May a further news story broke in relation to the ongoing trade talks between China and the US. These talks are set to resume on 2ndJune and, in what we currently perceive to be a simple device intended to concentrate minds, Trump has again raised the threat of imposing tariffs on Chinese imports to the USA.
The fact that any detail of these tariffs will not be announced until mid-June and only potentially then come into force at the end of June does rather suggest that this is no more than an unsubtle basis for negotiation on the future trading relationship and ongoing balance of trade between the two largest economies in the world.
Turning now to Europe. In a shameless attempt to overturn the result of the recent election in Italy and so subvert the will of the majority of Italians, the EU has pressurised the current Italian President (a position not noted for its longevity) into refusing the right of the victorious parties to form an anti-EU government.
This deliberate denial of democracy may eventually come back to bite them. However, given the EU project’s long historical record of escaping from the tightest of corners we would not discount its ability to manufacture a method of circumventing the burgeoning Italian financial crisis.
In a typical show of arrogance and complacency from an unelected technocrat, the European Commissioner for Budget and Human Resources (Gunther Oettinger) was quoted as saying that “the markets will teach the Italians to vote for the right thing”. Oethinger obviously remembers (as do we) that, in 2011, the EU toppled Berlusconi’s elected Italian government by manipulating bond spreads to exert maximum financial pressure on Italy. It will no doubt use the same tactics again but Italy is a bigger nut to crack than Greece was and have more cards to play with.
Sadly, the EU continues its preferred response to any challenge by refusing to listen to alternative points of view and simply seeking to bury its head in the sand. If it persists with that inherently anti-democratic approach then it may well discover that burying one’s head in the sand inevitably leaves another part of the anatomy fully exposed.
More seriously, the EU’s unwillingness to adapt to a rapidly changing world could very easily lead to catastrophe (not just in Italy but throughout Europe) from political, economic and monetary points of view. We are attuned to further developments and will aim to position the Fund’s assets accordingly.
Following the fluctuations of March, equity markets were smoother in the early weeks of April but that calmness soon turned out to be a false dawn as volatility returned with a vengeance in the last ten days of the month when intra-day price swings of 5 to 6% were commonplace.
For many years past we have observed with a mixture of amusement and amazement the institutional myopia (or blinkered idiocy) of market analysts and, by extention, their influence on market makers and equity pricing. If we were to compile a list of all the predictions (both by number and in percentage terms) that analysts got wrong and still consistently continue to get wrong it would challenge War and Peace for its lack of brevity.
It never ceases to surprise us that these organisations (which largely comprise the major investment banks) scour the best universities for the best brains but when these very talented people are inducted they are then discouraged from independent thought (or, indeed, any thinking at all) in favour of accepting without question a bland, prosaic, superficially risk-averse house style. In many cases, however, they often fail to grasp more profound and meaningful concepts of risk at all. Strangely though, they tend to be highly attuned to the concepts of corporate profit and self-enrichment.
These highly trained analysts are employed to make assumptions and prognoses on economic and geo-political issues; their assumptions very quickly mutate into ‘fact’ and, because very few dare to be out of step with the mainstream, then group-think is allowed to prosper. Whilst arrogance, compalcency and the certainty of their own infallibility causes relatively short term negative effects on equity valuations, it also has the benefit of providing investment opportunities and good value for those with an alternative (perhaps more considered and less self-interested) viewpoint.
Under specialist utilitarian training the intelligence, open-mindedness and natural optimism of youth is quickly transformed into an army of Jeremiah’s*; Jerry can swiftly becomes Jerry can’t. Perhaps if this army could be matched with a similar number of Cassandra’s** then between them they could continue to produce tediously depressing off-beam and negative analysis but nobody would actually believe it. That fanciful piece of wishful thinking will, of course, never become reality but it might at least give us some relief from these regular periods of pointless and synthetic market turbulence.
On 30th April 2018 the FTSE100 closed the month at 7509.30, a rise of +6.42% for April and it now stands at -2.32% for the 2018 calendar year to date.By comparison the Quotidian Fund’s valuation at the same date shows a profit of +1.38% for the month and the Fund is now standing at down –0.02% for the 2018 year to date.
Some analysts are more read (or should that be more red) than others but one example will suffice to illustrate the point I am trying to make about the poverty of mainstream analysis in general:
The share price of Facebook at close of business on 16thMarch was $185. The following day the ‘privacy scandal’ involving Cambridge Analytica’s apparent misuse of the personal data they had obtained from Facebook became public and this army of insightful analysts sprang into action. En masse, they made the assumption that this manufactured ‘scandal’ would cause catastrophic falls in customer numbers which, in turn, would lead to a huge drop in advertising revenue and profitability. In effect they were predicting that this could signal the demise of Facebook and by 27thMarch its share price had been marked down to $152. By association, the tech sector generally was also priced downwards across the board by circa 4%.
As we had signalled in our March report, the 2018 first quarter reporting season was just beginning and, with their share price having been under the cosh since 27thMarch, Facebook issued their latest results after market on 25thApril. Far from being in accord with analyst’s gloomy predictions, earnings per share were $1.69 (24.8% higher than analyst’s estimates of $1.354), and the number of monthly active users had increased to a not insignificant 2.2 billion (in the previous earnings report for 4thquarter 2017 it was 2.13 billion). Naturally, this will have a positive effect on future revenue and earnings per share.
In the blink of an eye, Facebook’s share price was revised substantially upwards again and is currently trading at $175 and it will go higher again. It is worth noting that in 2008 Facebook’s revenue was $272 million for that entire year; in 2018, its revenue is now $272 million every 2 days!
A similar story applies to the tech sector in general and the likes of Amazon, Apple, Google and Netflix in particular. Amazon’s share price was marked down, for entirely artificial reasons based on poor analytical judgement, from $1605 on 12th March to $1371 by 2ndApril.
Amazon’s results (released after market on 26thApril) were also exceptional (in complete contradiction to so-called ‘serious analysis’) and its share price immediately after the results were released soared up to $1625. We now expect to see the dark cloud that has been (deliberately) held over this sector for much of the past few months to be progressively lifted.
In view of the persistently negative reports and analyst’s warnings in relation to the tech sector it is worth emphasising that this sector includes the five largest companies in the world in terms of their market value. Quotidian has an equity holding in each of them. These five companies rarely sem to find favour in analyst’s reports but collectively they are worth more than the entire economy of the United Kingdom. Together they are currently valued at $3.5 trillion; the gross domestic product of the U.K. was just $2.6 trillion in 2017. In fact, only four national economies are larger than these tech giants combined: those of the USA, China, Japan and Germany. Despite their current size, they are still growing and making extraordinary profits.
Facebook, Microsoft, Amazon and Google (aka Alphabet) reported exceptionally large profits last week.
Facebook’s profits were almost $5 billion in the first quarter of 2018. That is equivalent to $56 million a day, $2.3 million an hour, $39,000 a minute. Amazon’s profits more than doubled and the fifth(Apple) releases its latest set of earnings on May 1st.
Apple makes roughly $151 million every day (a figure calculated from the company’s expected profit in the January/March quarter and which will be released after market on May 1st).
Google and Facebook can afford to offer free services thanks to their hammerlock on digital advertising. These two companies will sell an estimated $61 billion in US online advertisements this year according to reliable research from eMarketer. That is roughly a quarter of the expected total spending in the USA on all forms of advertising and yet it is all in the hands of just these two companies.
Amazon has just announced that it is raising the annual price of its Prime membership program for customers in the USA from $99 to $119, This simple change will generate an extra $2 billion for the company. Incredible.
The current US earnings season is shaping up to be one of the best in the last 20 years (based on the percentage of companies that are beating estimates). To return to my main theme, by the end ofApril those companies that have already reported their results have mainly posted phenomenal earnings and profit figures. Indeed, nearly three-quarters of those companies that have thus far reported have beaten analyst’s expectations.
These companies are not currently being rewarded with higher stock valuations. Instead, prices are basically flat despite these strong earnings reports but when the prevailing period of negativity passes then the financial reality of these achievements cannot simply be ignored; eventually they will have to be factored in to equity values.
The other item of April’s economic news that needs to be mentioned here is that on 24thApril the yield on US Treasury Bonds briefly hit 3%. You may recall the relevance and importance of that figure from our various briefing reports over the past year. If one can achieve a 3% yield with no risk to one’s nominal capital (other, of course, than the effect of inflation) then some investors will be tempted to move from equities into Treasury Bonds.
However, the 1o year yield has already slipped back again; if and only when it establishes itself above a 3% yield would we expect a relatively small amount of slippage from the equity markets into government debt.
The real importance of this issue it to stress again how vital stock selection, insight and patience are in order to firstly create and then maintain an equity portfolio which can provide attractive, above average investment returns combined with a reasonable level of security. This is Quotidian’s raison d’etre.
* Jeremiah – the weeping prophet, relentlessly negative
**Cassandra – whose prophesies were sometimes right but nobody believed her anyway
The turbulence that has dogged global stockmarkets since late January reasserted itself from the third week in March through to the end of the month. A downturn in January/February (during which all major markets around the globe saw a 10%+ fall in valuations) had recovered rather quickly (certainly in less than the 3 months we would normally expect such a recovery to take) and so it came as no surprise to see a further correction before prices begin to move higher again.
Just to put this current period of market instability into focus for you let me compare the last quarter of 2017 with the first quarter of 2018 by illustrating the number of trading days that the market moved by more than 1% (either up or down):
- in the first quarter of 2018 the S&P 500 index moved by greater than 1% (up or down) on 23 trading days (of the 62 trading days in that quarter) whereas, by comparison, in the last quarter of 2017 (also 62 trading days) it did not exceed that 1% daily movement even once.Zero trading days of volatility!
- Similarly, the Nasdaq index exceeded 1% daily movements on 25 trading days in the first quarter of 2018 compared to just 6 trading days in the final quarter of 2017.
- And just for completeness, the figures on exactly the same bais for the FTSE 100 index are 13 trading days during the first quarter of this year set against only 4 trading days in the last quarter of 2017.
Equity markets are, of course, inherently dynamic and have occasionally bouts of extreme volatility but even in such periods of uncertainty there are usually still sectors and individual stocks that will hold up and continue to grow despite general market unease. Having said that, even these sectors and specific stocks are not immune from typical short-term market gyrations.
Market makers were keen to ascribe the March mark-downs to concerns over a potential global trade war as a result of President Trump’s decision to impose tariffs on steel and aluminium imports to the USA. Having observed and analysed Trump’s negotiation tactics over the past year or so (which typically begin with heavy artillery as a means of kick-starting real negotiations) we see these comments from marlet-makers and, strangely, from largely left wing dominated media sources as nothing more than disingenuous and self-serving. Trump’s real target is China and, in particular, the detrimental effect that its subsidized and therefore artificially cheap exports to the US have on US industry and employment.
In line with Trump’s typically and quite deliberate bullish opening salvo with the simple intention of bringing about a negotiation, we have no doubt that the US and China will successfully resolve their trade issues through dialogue and conciliation. Indeed, the fact that China’s retaliatory tariffs have already been introduced and can be seen to be more for appearance and face-saving purposes, indicates that China is very willing to ease the intensity of any potential trade conflict. The fact that their new tariffs are not substantial and do not cover some of the US’s biggest exports to China is a reliable signal that Beijing clearly wants to avoid an all-out trade war.
Of more relevance to the real world and genuine stockmarket action, a sell off in technology stocks was sparked towards he end of March when Facebook was found to have enabled the unauthorised use of personal data by one of its associates (Cambridge Analytica, a company that specialises in data mining and analisis for political and advertising purposes). The concern is that this careless, not to say cavalier, approach to personal privacy could lead to the introduction of new and intrusive regulation across the technology board. However, any move towards regulation would rather overlook the fact that Facebook users have freely chosen to put their personal details on display in the public domain in the first place.
Before leaping to ignore personal freedom of choice in favour of regulation and control (increasingly the favoured political response to every tiny area of our private lives) our poltical classes would do well to take into account that the world is run on US software. From work productivity to entertainment, from graphic design to database management, the world runs on ubiquitous American software. In essence, US software is the world’s operating system and any restrictive regulation upon it could have unintended, expensive and undesired economic effects.
Reverting to the subject of potential trade wars, it is very unlikely that foreign governments would decide to place restrictive tariffs on these American technology products as it would immediately increase prices for almost every sector of their own economies, including the costs of running their own governments.
In the UK and Europe, it may simply be coincidental but it does seem rather strange that the Italian election result (dominated, as expected and trailed in last month’s report, by the two successful anti-EU and anti-euro parties) has been closely followed by a complete change of tone and attitude towads the UK by the EU’s Brexit negotiators. Hopefully, if the EU’s more realistic approach is maintained, this will be reflected by a more positive tone in the UK stockmarket too.
Over the next few weeks the 2018 first quarter reporting season will begin. Advance estimates suggest that those companies that comprise the S&P500 Index will report that earnings growth will have risen by 17% in the first 3 months of this year; if so, this would be the largest increase in profits since the first quarter of 2011. Whilst we wait to see whether this apparent surge in profitability comes as a result of increased sales and/or lower costs (increased efficiency) or is largely a function of the new tax regime introduced by Trump’s administration, increased profits should be reflected in share valuations.
In our January report we highlighted the fact that a global stock-market correction was long overdue and the likelihood that the week-long fall back in the UK at that stage together with three successive days of negativity in US markets was evidence that a realignment of market values was underway.
The classic definition of an equity market correction is a decline of 10% in market valuations. A market crash is similarly defined as a fall of 20% plus.
As February progressed, the FTSE100 did indeed fall by 8.82% from its previous peak in mid-January (and, intraday, it did exceed a 10% drop on 9th February before recovering slightly to close at that figure of -8.82%). At close on 28th February the Footsie is still down -7.03% from its January high point.
In the USA, the S&P 500 index fell by 10.16% from its January high and is still down -5.54% at the end of February. The tech-heavy Nasdaq market fell by 9.70% (although, intraday, it also exceeded the 10% ‘correction’ level). The Nasdaq has now recovered to stand at just -3.10% down from its recent high.
We saw those market declines as an ideal buying opportunity and so we began to rebuild our equity holdings on market down-days to the extent that we were 45% invested throughout much of February. The last two trading days of February have given us yet another attractive chance to buy more and we will continue to buy on market dips until our ideal portfolio requirements are filled. The effect of these last two days of increasing our holdings is that we are now 66% invested.
On 28th February 2018 the FTSE100 closed at 7231.91, a fall of– 4.00% for the month and it therefore stands at -5.93% for the 2018 calendar year to date. By comparison the Quotidian Fund’s valuation at 28th February shows a fall of -0.28% for the month and it follows that the Fund is now up +0.52% for the 2018 year to date.
The UK stock-market is still in thrall to seemingly never-ending Brexit negotiations and, until a degree of clarity emerges, we see no great advantage to be gained from anything beyond minimal and sharply-focused exposure to it. It has been perfectly clear from the outset that the EU has no intention of negotiating a reasonable and equitable exit deal with the UK; it’s intention is simply to frustrate the process and (with the help of a motley collection of ‘useful idiots’) ultimately aim to derail the whole thing. We can but hope that some real leadership in UK political circles makes itself evident sooner rather than later.
In Europe, the Italian general election on 4thMarch may become an interesting and helpful feature of Brexit negotiations. Polls in Italy are predicting that the votes will be shared between the two largest anti-EU parties (but with neither party achieving an overall majority) and with the current Democratic Party regime (personified but no longer led by the EU puppet, Matteo Renzi) finishing a distant third.
Not only are the two likely highest vote-winning parties (Forza Italia and Five Star Movement) anti-EU, they are both anti-Euro too and have threatened to reject and replace the Euro as Italy’s currency. Sunday’s result will be interesting to say the least and it may well help the UK’s position in that it will create a second profoundly negative front to occupy the attention of the anti-democratic EU bureaucrats.
In the USA, its economy is clearly expanding and economic fundamentals are still very positive. Its new tax rules are helpful for the stock market and they also reinforce prevailing positive consumer confidence and spending. In our opinion these factors alone are bullish for the US stock markets.
In the past it has, on average, taken markets 56 trading days (roughly 3 months) to recover the ground ceded following a correction. We therefore anticipate continued short-term volatility but if that turbulence continues for longer than usual (or longer than we expect it to) then we have kept funds back to buy more of our chosen assets at even lower prices. In the medium to long term this is a very positive strategy.
We noted in our December report thatit would not be a complete surprise if the artifice and froth of the ‘Santa rally’ were to disappear again in the early part of the New Year.
In fact, the London market’s exuberance continued through the first two weeks of January but eventually economic and political reality reasserted itself and equity valuations in the UK fell back again into negative territory by the month end.
Conversely, stock-markets in the USA continued relentlessly to make record highs and trading activity in US equities in the last full week ending 26thJanuary saw an inflow of US$7 billion. US markets have now surpassed their previous longest-ever period without having at least a 5% correction. However, as the US dollar continues to weaken against the pound, their equity returns to a sterling investor have been subdued.
There continues to be a great deal of speculation in the media about an impending stock-market crash and, in broad terms, we agree with the premise that a correction (not a crash) is overdue. That, of course, is why we substantially reduced the Fund’s exposure to equity markets last July by going largely into cash and, to date, this decision has served us well.
In the medium to long term, though, cash is an unimaginative, unproductive and risky place to hold one’s money. As evidenced above, flight capital continues to flood into the USA and the paltry yield available in Treasury Bonds (T-Bonds) simply drives that money towards equities. Whilst this weight of incoming money continues, historical market certainties seem to be temporarily in suspense.
On 31st January 2018 the FTSE100 closed at 7533.55, a fall of -2.01% for the first month of the New Year, and it therefore stands at -2.01% for the 2018 calendar year too. By comparison the Quotidian Fund’s valuation at 31stJanuary shows a rise of +0.81% for the month and it follows that the Fund is also up +0.81% for the 2018 year to date.
The financial media is fond of making reference to CAPE (Cyclically Adjusted Price Earnings ratio) and PE ratios as measures of equity market attractiveness. We look most closely at the current Price/Earnings (PE) ratio. Over the years a PE ratio of 16 has been seen as a reasonable average and a good touchstone for making value judgements on equity investment. In terms of evaluating the market as a whole, anything higher than that is an indication that the market is over-valued; conversely, anything lower is obviously seen as the market being undervalued.
The current PE ratio of the S&P500 (as a proxy for global markets) today is 26.4, indicating that the market generally is indeed overvalued. But the PE ratio just before the dot-com bubble burst stood at 40 and that suggests that we appear to be a long way away from ‘crash’ territory.
Another issue which, perhaps temporarily, supports current valuations is that the figure quoted above in relation to trading volumes in the US validates the assertion that there is still a huge wave of flight capital flowing into the USA from troubled parts of the world. In years gone by a large percentage of that incoming capital would find its way into Treasury Bonds (the US version of gilts) which were then seen as the safest of safe havens.
To develop that theme; the best measure of Treasuries as an investment alternative to equities is the 10 year T-bond which, at the moment, is yielding just 2.60%. Prospective T-Bond buyers are therefore faced with the deeply unattractive prospect of exchanging their capital in return for a 2.60% annual income and the return of just their original capital in ten years’ time (with no prospect of growth in either the coupon payment or the capital). Alternatively the yield alone on the S&P market for example is 3% and there is the strong prospect of capital growth over a 10 year period too. It is unsurprising therefore that the majority of this flight capital is flowing into the stock-market (instead of into Treasuries) and so supporting current equity valuation levels.
Exactly the same rationale applies to the UK market where the return on 10 gilts is presently running at 1.4%.
A further consideration is that the latest quarterly earnings reporting season is now underway and, perhaps surprisingly, has largely been supportive of current equity valuations. In the USA by the end of January, 204 of the companies in the S&P500 had reported their results and, of these, 167 (that is, 82% of them) had declared positive earnings surprises. The majority had also announced better than expected sales figures too.
Of course, these situations will evolve and when annual yields on 10 year T-bonds eventually come back up to exceed 3%+ and, in the UK, rise to at least exceed inflation then monies will again gravitate towards bonds at the expense of equities. We still appear to be a distance away from that situation right now. As and when circumstances change we will reconsider our investment strategy accordingly. In the meantime, equities hold sway in our strategic planning.
However, we have now to solve the conundrum of when and how to take up equity positions again and we have been weighing up the evidence, much of it outlined above.
We have already selected our portfolio; we know exactly what we want to buy and have simply been patiently waiting for an appropriate time to get back in to stock-markets. In particular we wanted to see a correction, ot at least a little downturn, before re-taking equity positions.
The fall back in latter part of January in the UK markets and three negative days in succession in US stock-markets gave us an ideal buying opportunity and so we have now begun to rebuild our equity holdings on a piece-meal (little by little) basis and we will continue to buy on market dips until our current portfolio requirements are filled.
Given the inherent nature of stock-markets there is always the risk of further downturns in equity valuations but if one has a well-chosen portfolio and is prepared to hold on through occasional periods of stockmarket volatility then capital values will inevitably recover. Perseverance, confidence, timing and patience are some of the necessary attributes in achieving the right long-term result.
Global stock markets were surprisingly calm in 2017 and went through the year with just an occasional downturn but without a really significant correction. In the UK, the FTSE100 index was constrained within a narrow trading range for much of the year until a typically superficial festive ‘Santa rally’ added a belated but unworthy gloss to a lacklustre year. In the USA, the S&P 500 index has now risen for a record 14 successive months but a weakening dollar diluted gains for a sterling-based investor. Neither of these situations are likely to persist.
On 31st December 2017 the FTSE100 closed at 7687.77 (a rise of+ 4.93% for the month) and it now stands at + 7.63% for the 2017 calendar year. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +0.06% for the month of December and the Fund has achieved an increase of +32.42% for the 2017 year.
It is worth noting that at the end of May the FTSE100 was up 5.28% year to date (YTD) whilst Quotidian at that point was up by 25.33%. Within a month of that date Quotidian took the decision to consolidate and secure its 2017 YTD profits by converting the majority of its portfolio into cash rather than remaining exposed to markets that were largely lacking motivation and direction.
In the seven months from the end of May to 31stDecember Footsie rose by just 2.23% (and all of that uplift in valuations came during Christmas week) whereas the Quotidian Fund (largely unexposed to stockmarket risk throughout this period) still managed to increase by 5.66%. It would not be a complete surprise if the artifice and froth of the ‘Santa rally’ disappears again in the early part of the New Year.
2018 will mark the 30thanniversary of Quotidian (under one aegis or another) managing clients’ money. Indeed, a significant number of clients have been with us since those formative years.
One of our earliest pieces of research was an analysis of UK-based mutual funds (Unit Trusts, OEICs and Investment Trusts). At that time there were just over 3200 of these investment vehicles available on the UK market and we were looking to identify reliability and consistency of performance as well as the effect of charges. We have a very specific self-developed proprietary method of measuring investment performance in such a way as to clearly separate the men from the boys.
The result of our scrutiny and evaluation showed quite clearly that only 54 of this total number cleared the hurdles that, in our estimation, made them worthy of investment consideration. Frankly, little has changed in the interim. I can recall that this research took very nearly four months of painstaking effort to complete. Nowadays, with the power and speed of computers and the depth of information available on their databases, this analysis can be completed more quickly, more thoroughly and more regularly throughout the year.
Towards the end of 2012 Quotidian eventually rid itself of any remnants of unnecessary and unproductive baggage and since the beginning of 2013 we have operated entirely independently under our own flag and using our own research.
The Quotidian Fund’s performance since 2013 has been:
- Over one year: +32.42% (FTSE100: + 7.63%)
- Over 3 years: +32.74% (FTSE100: +17.08%)
- Over 5 years: +66.68% (FTSE100: +30.35%)
Quotidian’s figures are net of charges and based upon exact calendar years (not cherry-picked nor cleverly contrived ad hoc periods of time). Res ipsa loquitur.
Our full analysis of global stockmarkets produces a similar result today both in respect of mutual funds and, more significantly, for individual stocks and shares too. For example, by our evaluation, of the roughly 4200 publicly traded shares in the US markets today no more than 50 could be regarded as suitable investments (certainly as far as the Quotidian Fund is concerned). And of that group, only a handful are currently trading at a price that makes them attractive for the time being. It is the same story in other markets around the world.
We are under no illusion that private investors are at a serious disadvantage when trying to deal in the world’s stockmarkets. Of course, stockbrokers and other self-interested parties will continue to recommend ‘sucker’ stocks simply because their income depends upon the commissions they can generate and in the knowledge that private investors can be relied upon to regularly take the bait. Many of these ‘sucker’ stocks are well known names. The graveyard of stocks that have fallen more than 80% in recent years include such once-famous names as Pitney-Bowes, Enron, Sears, Royal Bank of Scotland, Motorola, Nokia and Cisco.
Sadly, market insiders (stockbrokers, market makers, major banks) use a technique they call ‘pump and dump’ to generate sales and commissions from unwary investors. It works like this:
Firstly they identify a well-known name (to give a degree of credibility and a mirage of security) whose stock has a high level of liquidity and preferably is undervalued. They then buy these stocks for themselves, often at bargain basement prices.
Their in-house analysts then write glowing reports on these shares and rate them as a ‘strong buy’. Then their ‘friends’ in the media and ratings agencies add to the hype, tout these stocks to typical retail clients and millions of small investors do just that. As a result, of course, the share price goes up…..which is when the brokers, banks and hedge funds get out, leaving unwary amateur investors holding the shares as their price drops back to its original level or below.
In some cases, lack of training and experience means that many of the enthusiastic young men sitting at sales desks in stockbroker’s offices or in the trading departments of the large battalion’s do not have the insight to realise that they, too, are being duped. It is difficult to get a man to understand something when his salary depends upon him not understanding it!
In the medium to long term cash is an unimaginative, unproductive and risky place to hold one’s money. In the short term, however, being in cash creates an opportunity to acquire worthwhile assets as and when cheaper buying opportunities arise (and one wouldn’t be able to take advantage of any price drops unless one has the cash available to buy).
And finally, a word of thanks. Without your support, Quotidian would not have the opportunity to pursue its professional passion of searching global markets for attractive investment opportunities. We truly value the trust you place in us and the confidence you maintain in our investment judgement. It is greatly appreciated and we are profoundly grateful. Thank you.
Equity markets continue to be generally uninspired and in the doldrums. Advances in US markets are followed by retrenchment and any stockmarket gains to a UK investor are being largely negated by a weakening dollar.
In the UK, deliberate political obstruction encouraged by a lack of leadership, clarity and purpose in relation to Brexit, combined with increasing instability related to the potential of a hard-left Labour party being voted into power, continue to suppress equity markets here far more than economic issues.
The EU’s political leaders and negotiators are being allowed, unfortunately, to dictate terms, retain the initiative and set the agenda. It is evident that their main aim is to extract a huge amount of money under the guise of a divorce settlement, to create a number of ‘impossible’ conditions and impose artificial timescales in the hope that they can eventually crank up sufficient pressure to circumvent Brexit altogether.
As ever, the EU remains strangely silent on its current sources of taxes and positively mute on its areas of expenditure (the consumers of their tax revenues). As best one can see of the financial position of an organisation whose accountants have steadfastly never been prepared to sign off audited accounts, the EU has thus far run up a vast level of debt and, despite that, has already committed itself to further huge expenditure in the future. Vanity knows no bounds.
Live now, pay later seems to be the mantra. The most reliable figure we have (courtesy of William Hague) is that the EU is underwater to the tune of 250 billion euros. No wonder they have invented such an enormous divorce bill.
Perhaps the UK’s negotiating team should stress the importance of the UK to the EU by reminding themselves and their counterparts across the channel that:
- The UK represents 16% of the EU’s GDP
- It comprises just 13% of the EU’s population
- Yet only 3.50% of the EU’s officials are British
- Britain is also the 2ndlargest net contributor to the EU coffers
- The EU comprises just 20% of the global economy
- The costs of complying with EU bureaucracy are estimated to reduce UK GDP by 7%
- In 1999, 61% of the UK’s total trade was with the EU; the latest figures show that it’s now only just over 40%. Ergo, just about 60% of UK trade is already now with the rest of the world
- There is a large defecit on the UK’s trade with the EU
- There is a substantial surplus on the UK’s trade with the rest of the world
- Current political chaos in Germany, Italy and Spain threatens to derail ‘the EU project’
Sadly, the EU’s negotiating tactics (not only with Brexit) are characterised by ferocious campaigns of truth reversal and character assassination. These campaigns are used simply to create an illusion of mass support in order to better manipulate and intimidate people. They are based on sustained misinformation, unevidenced allegations and downright lies. Our friend Juncker continues to make himself look foolish; but then again he’s had plenty of practice.
Finally on the wearisome topic of Brexit (and it appears regularly in our reports simply because it continues to be the most important influence currently on the UK equity markets). In an interview early in November, James Dyson, an excellent businessman who has an impeccable record of invention and solid achievement, stated that years of experience had taught him that you simply cannot negotiate with the EU. In his view, Britain should just walk away and “they will then come to us simply because they need to sell us their goods”.
It is readily apparent that the EU’s negotiating style is to test the UK’s resolve to breaking point. Whenever past referenda outcomes have gone against them, the EU has used the same tactics in order to achieve a reversal of the democratic result and so they are used to these devices ultimately leading to capitulation. From the UK’s perspective, the EU must therefore be made to understand that we are not bluffing and to achieve that goal they must be brought to a realisation that the the UK will indeed walk out of negotiations, whatever EU threats (and empty threas they are) may be made, if an equitable deal is not made available.
One should also beware of the rather sleazy EU phrase “nothing is agreed until everything is agreed”. This is also just a tactic to wear down the opposition. In the last few days of November there is a suggestion that the divorce settlement figure has been agreed. In our view, that is far from the truth. In due course the EU will revisit that number with a view to pushing it even higher.
In addition to that, the financial reality is that when the second largest net contributor to the EU Treasury leaves the European Union the remaining 27 members are left with the dilemma of whether to cut their budgets or increase the national contributions of each remaining country. It is not in their political DNA to cut budgets! That is the root cause of their desperation to extract a substantial and unsubstantiated divorce settlement.
There has been a distinct movement to the political right in various recent elections and referenda throughout Europe. Perhaps the imminent unseating of the once all-powerful Angela Merkel will add velocity to this trend towards the conservative (small ’c’) ideal of free trade. It can only benefit European and UK equity markets if that happens.
On 30th November 2017 the FTSE100 closed at 7326(a fall of– 2.22% for the month) and it now stands at only +2.57% for the 2017 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +0.17%for the month of November and the Fund is now up+32.33% for the 2017 year to date.
The Quotidian Fund has the facility to short equity markets with a view to making profits in falling markets. However, our overriding principle is that we seek to expose the Fund to risk (either long or short) only when we perceive an established trend, either positive or negative, and the potential opportunity for significant profit.
For the past six months global markets have been generally going sideways and are presently constrained within relatively narrow trading ranges.
We therefore take our cue from The Grand Old Duke of York; when we are long (buying the market) we are long and when we are short (selling the market) we are short, but when we are only halfway up (if we deem the risk/reward ratio to be unattractive) then we are out, unexposed to stockmarket hazards and unseduced by the temptation of what would likely turn out to be return free risk. Keeping the powder dry until a better balance of risk emerges.
Over the past few years the EU has made a nasty and repetitive habit of trying to impose random fines on major US tech companies either under the guise of them having received ‘illegal state aid’ or, seemingly, simply for being too successful. Perhaps this reflects a belated underlying recognition that the EU’s revenue generators are overwhelmed by the EU’s revenue consumers.
This year alone Google, Apple and Amazon have been in the firing line to suffer these arbitrary haircuts.
In June the EU fined Google 2.4 billion euros for ‘unfairly dominating the search and advertising market’. At the end of August it also fined Apple 13 billion euros (a figure apparently plucked from thin air) in respect of ‘unpaid taxes’ after the EU argued that Ireland had apparently granted ‘illegal state aid’ to Apple by virtue of a favourable tax regime.
In this instance the EU employed the sly device of instructing Ireland to collect the penalty fine. By the end of October and in the absence of any settlement, the EU announced that it is now taking the Irish Government to court in order to extract the uncollected fine! All one happy family!
Earlier this month Amazon became the latest target of the EU’s gaping fiscal maw. The European Union is asserting that Amazon used Luxembourg as a tax haven and that it had received ‘illegal state aid’ by virtue of a ‘sweetheart’ deal with that country for the period between 2003 to 2011. A fine of 250 million euros (another conjuring trick) has been imposed.
It is interesting to note that the Prime Minister of Luxembourg from 1995 to 2013 was none other than Jean-Claude Juncker! Indeed, the slippery Monsieur Juncker was simultaneously Luxembourg’s Minister of Finance between 1989 and 2009. It would therefore be beyond parody to suggest that he would have been entirely unaware of these now so-called illegal arrangements. At the height of the original Greek bail-out crisis Juncker was quoted as saying that “when things become serious you have to lie”. No wonder that Brexit negotiations are moving ever so slowly!
The active ingredient and common thread in these tawdry attempts to fill the EU’s coffers is EU Commissioner Margrethe Vestager whose approach is typical of the totalitarian, anti-business bully-boy tactics so often employed by our continental friends. They clearly see businesses as bottomless pits of finance to be endlessly milked in order to cover the EU’s gross overspending.
However, in taking on the US tech giants the EU has bitten off more than it will be able to chew and its vain, naïve attempts to extract fines on trumped up charges is highly likely to backfire. In mid-October the US Senate finally gave the green light to Donald Trump’s long awaited new tax plans. These will benefit individual US taxpayers but, in particular, they are framed in such a way as to encourage US multi-national companies to repatriate their profits to the USA where they will now face a much-reduced corporation tax burden. One day the EU will perhaps begin to understand the shortcomings inherent in their dictatorial, autocratic socialist paradise compared to the benefits of international consumer choice. They might be surprised to discover that the customer (or, in this case the taxpayer, whether individual or corporate) can vote with his feet. The consequential loss of long-term business revenues and loss of consumer spending in EU markets far outweighs the blinkered short-term ‘fix’ of synthetic, concocted fines.
Following the unwinding of Quantitative Easing announced in the US in September the European Central Bank followed suit, to a degree, in October. With effect from January 2018 the EU will reduce its QE commitments from 60bn euros down to 30bn euros per month. However, the EU’s QE programme has now been extended to September 2018 with the additional promise that it will be further extended forward again if necessary. Mario Draghi is clearly still intent on ‘doing whatever it takes’ to paper over the EU’s financial cracks but the problem with playing the extend-and-pretend game with finances is that eventually the music comes to a grinding halt.
On 31st October 2017 the FTSE100 closed at 7493(a rise of+1.63% for the month) and it now stands at +4.90% for the 2017 calendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +0.35%for the month of October and the Fund is now up+32.10for the 2017 year to date.
To quote Warren Buffett, “interest rates have always been a powerful factor in equity valuations”. The yield on US Treasuries today is just 2.39% and so prospective buyers are faced with the deeply unattractive prospect of exchanging their capital in return for a 2,39% annual income and the return of their original capital in ten years’ time (with no prospect of growth in either the coupon payment or the capital). Return free risk still persists in the bond market.
By contrast, the dividend yield on the S&P500 is roughly 2% and on top of that investors have the prospect of growth in the dividend return as well as capital appreciation. Of course there is always the risk of a downturn in equity valuations but if one has a well-chosen portfolio and is prepared to hold on through the occasional stockmarket storm, capital values will inevitably recover. Perseverance, confidence, timing and patience are some of the necessary attributes in achieving the right long-term result.
However, to introduce a more negative note just to balance the argument with historical data; using the S&P500 as a realistic proxy for global equity markets, momentum continues to be modestly positive although investor confidence is somewhat less so. As I write, the S&P500 has now gone for 363 trading days without at least a 5% downward correction. In the past 65 years there have only ever been three longer periods without a significant negative readjustment. During 1964/65 equity markets went for 386 trading days without at least a 5% decline; between 1993/94 it was 370 days and between 1995/96 it was 394. The current situation is therefore perilously close to creating a new record. It may well be that the continuing flow of flight capital into the USA stockmarkets (as referenced in our September report) is the proximate cause of this but by the very nature of equity markets they inherently require a correction to remove ‘froth’ before re-gathering upward motion.
Our aim is to invest with an acute awareness of the risks (economic and political) around us on a daily basis. In doing so, we seek to protect our portfolio as best we can during the inevitable periods of market declines. Having taken shelter away from equity markets since July we would actually be much in the same place valuation-wise today as if we had remained exposed to market risk. As outlined above, there are some compelling reasons to recreate our equity portfolio but the continuing risks posed by experimental monetary policy and heightened geo-political tensions (North Korea and Catalonia in particular) still persuade us to bide our time for the moment.
On 20thSeptember the US Federal Reserve decided, not before time, to put quantitative easing into reverse by unwinding the huge portfolio of bonds it had built up through its efforts to safeguard and stimulate the US economy following the financial crisis of 2007 onwards.
After buying up US treasuries and mortgage-backed securities as part of its ‘easing’ programme the US central bank’s balance sheet has expanded to $4.5 trillion; around four times its size before the financial crisis. As it now looks to move monetary policy away from what had originally been intended as a short-term emergency measure, from October and each month thereafter the Federal Reserve will start to unwind those holdings at the rate of $10bn per quarter. We see this as a positive sign of strength and confidence in the US economic recovery.
In line with the Federal Reserve’s approach under the stewardship of Janet Yellen it has been at pains to avoid a repeat of 2013’s ‘taper tantrum’ when its surprise announcement (under Ben Bernanke) that it would start reducing the amount of bonds it bought caught financial markets on the hop and sparked a steep and vicious sell-off.
In complete contrast to the unwelcome surprises regularly delivered under Bernanke (and even moreso the disasterous Alan Greenspan before him) this latest move had been well flagged with the result that markets reacted calmly to the news.
Greenspan, who turned obfuscation into an art form, is best remembered from his statement that “if you think you understand what I’m saying then I’m not making myself clear”! A similar quote of his along the same lines was “if I turn out to be particularly clear then you’ve probably misunderstood what I’ve said”.
He and his deliberately obscure style was the direct cause of so many periods of extreme volatility in stock-markets as well as being directly implicated in the origins of the sub-prime loans crisis (which, in turn, was the proximate cause of the global financial crisis). It is quaintly ironic that , at the age of 91, he is still regarded in some circles in the US as a financial guru!
In her post-meeting statement Yellen said that “the basic message here is that US economic performance has been good” and in view of this strength she signalled that there was a high likelihood of another small interest rate rise in December followed next year by the prospect of three similar modest increases.
This latest announcement is significant as the Fed’s tightening will further increase capital inflows to the USA from Asia and the world’s economic or political trouble spots.
On 30th September 2017 the FTSE100 closed at 7318(a fall of– 0.78% for the month) and it now stands at just +3.22%for the 2017 callendar year to date. By comparison the Quotidian Fund’s valuation at the same date shows a rise of +0.53%for the month of September and the Fund is now up+31.64% for the 2017 year to date.
As we enter October some of our technical indicators still show that it is not all sweetness and light in global markets despite the positive signals from the USA economy and the Federal Reserve. In some areas of the globe we note:
- increasing pressure on some already massively indebted governments
- a lack of confidence illustrated by stagnant or falling consumer spending and by the hoarding of cash by businesses rather than re-investment of earnings into business development
- a rising tide of potential conflicts that presently threaten Japan and Europe and which is adding further to the flood of flight capital to the United States.
Japan is at the centre of two of those conflicts:
Firstly, it is embroiled in a long battle with China over the Senkaku Islands in the East China Sea and at the same time Japan is also in the firing line of the North Korean dictator Kim Jong-un.
The chances that China will invade Japan or that North Korea will actually bomb Tokyo are currently still infinitesimally small but there is little or no chance that Japan can escape the economic impacts of these threats. Its Prime Minister is trying to swiftly push through a massive defence build-up that Japan simply cannot afford. Long before this latest North Korean crisis began the Japanese government was already struggling to deal with an economic crisis of its own making.
Japan’s government is saddled with the largest sovereign debt in the world; more than one quadrillion yen in debt (that’s a 1 followed by fifteen zeros) and it means that even if the country had a annual budget surplus of one trillion yen it would still take 1,000 years for Japan to pay off its current liabilities.
Tokyo’s existing debt is nearly two-and-a-half times the size of the entire Japanese economy and far larger than the over-indebtedness that pushed Greece, Ireland, Italy, Spain and Portugal to the brink of collapse. Worse still, Japan’s debt is still trending upwards partly because of its servicing costs but largely because the government is committed to social welfare spending, which already accounts for one-third of its 106-trillion-yen budget and is rising automatically by about one trillion yen every year.
In Europe the sovereign debt crisis we first saw a few years ago in Greece and the other PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) was only the tip of the iceberg.
- Despite repeated bailouts, 22 of the present 28 EU member states (including Spain, France, Italy and the UK) are deeper in debt now than ever before.
- In Spain and France, it would take virtually every penny generated by their economies in an entire year to equal their national debts.
- Portugal owes 29% more than its economy produces in a year. In Italy it is 33% more.
- The Greek government, still in dreadful shape even after six huge bailouts, owes 76% more than its economy produces.
- In contrast to the US decision to taper quantitative easing and phase it out, the European Central Bank still have their printing presses in full swing creating 60bn euros per month from thin air.This extreme and protracted central bank intervention was what Dragi meant when he promised to ‘do whatever it took’ to save the Euro and, indeed, it is the only thing saving the Eurozone from implosion under the weight of its own indebtedness.
At the same time as presenting this vision of the EU as a land of milk and honey, Juncker was busy behind the scenes trying to frustrate and repress a referendum in Catalonia to determine whether the majoriy of Catalans would prefer to secede from Spain and form an independent state. Unlike the economic background to the Scottish referendum, Catalonia is the wealthiest and most productive region of Spain and if it were allowed its independence then that would risk destroying the supposed integrity of the Euro (and, thereby, the EU project itself).
Predictably, the very same ‘Project Fear’ tactics used in the lead-up to the UK Referendum have been in evidence and taken to even further extremes. Despite the fact that a referendum was originally agreed to by Madrid (albeit under a different Prime Minister), it has now been declared to be illegal and attempts have been made to prevent polling stations from opening. It would be difficult to find a better example to illustrate what freedom of expression and choice really means Juncker-style in a centralised, anti-democratic federal paradise that exists only in the minds of EU technocrats, the politically myopic and the economically naïve.
History shows that politicians can ignore and frustrate majority public opinion for decades, but not forever. Hubris is invariably followed by nemesis (even if there is sometimes a long time-lag between them). At some point in the future the piper will have to be paid and it would somehow be quite fitting if he came from Hamelin.
From an investment perspective, for the time being all of this will simply add to the flight of capital towards the USA, which is still seen as the safest of financial havens.
A reliable investment mantra in years gone by was that if money supply was tight (that is, if it was difficult and expensive to borrow money) then the stockmarket would head south. Conversely, if money supply was loose (if it was cheap and easy to borrow) then stockmarkets would rise. Of course, those were in the days of exchange controls to limit movement of capital and when markets were comparatively naïve and parochial.
Nowadays, stockmarkets are global and more sophisticated. Huge sums of money can be transferred around the world in the blink of an eye and at the press of a button and, in continuation of the trend we’ve witnessed for the past few years, this flight capital will continue to flow into the US stock markets and support what, in times past, would have been seen as over-extended valuations.
At present we remain just 10% invested in equities with the balance of the Fund invested in cash. A proportion of that cash balance is held in US dollars and has been a welcome source of recent gains as sterling has appreciated against the dollar.
When we believe that the time is right to re-enter equity markets we will remain shy of the problem areas of the global markets outlined above and seek to re-establish a portfolio comprising a focused and relatively small number of carefully selected growth stocks that we trust.
Year after year, equity market trading volumes in August are extremely light, reflecting the fact that large numbers of market makers and traders are away on their summer holidays. 2017 has been no different and so price action in equities throughout August has continued to be subdued but also very volatile.
This month’s report is therefore shorter than usual (which will no doubt be a blessing for regular readers of my turgid prose) simply on the basis that when there is nothing of substance to say then it’s best to say nothing.
August’s bumpy market ride is best witnessed by the fact that the S&P 500 has had as much daily price volatility in the most recent 12 trading days (to the end of August) as it had experienced in the first 152 trading days of 2017 (that is, from start January to end July). Intraday swings in the index of 1% or more have been a notable feature.
As ever, global markets follow the lead set by the USA and so the UK market in August has been equally capricious. The more cynical among us are inclined to interepret this price manipulation as a series of traps set during quiet and light volume trading periods in the hope of seducing the unwary into what superficially might be perceived as the start of upward momentum. In our view the siren’s call should be resisted, certainly for the time being.
On 31st August 2017 the FTSE100 closed at 7340.62 (a rise of +0.80% for the month) and it now stands at +4.03% for the 2017 year to date. By comparison the Quotidian Fund’s valuation at the same date shows a decline of -0.33% for the month of August but for the 2017 year to date the Fund is up +30.95%.
Since 1992, August has invariably been the worst performing month of the stockmarket year. Over that 25 year time period the S&P 500 index has suffered an average loss of 0.70% during August. Conversely, the best performing month over that same timeframe has consistently been April.
Of the 21 holdings we disinvested from for safety’s sake at the end of June, all but 2 of them are now trading at lower valuations. There will, of course, be an appropriate time to buy back into them all but, for the time being, we continue to be happy to sit out of equity markets until the geo-political picture becomes clearer, the global economic situation gives us greater assurance that upward momentum is more than just a mirage and that the risks inherent in equity investment revert to a point where, on balance, the potential for profit becomes more compelling. We remain vigilant.
Having said that, we also recognise that in 11 of the past 14 calendar years the S&P 500’s high point for the year has been achieved between September and December. More pertinently, over the past 25 years the last quarter of the year has consistently comprised three of the best-performing months on average for the S&P 500 Index. October ranks second-best, November third-best and December fifth-best. Taken together, these three months have produced 54% of the index’s total return. Opportunity may knock.
Price action in equities throughout July has been unpredictable and difficult to interpret as markets have been volatile but have also remained within defined trading ranges.
The FTSE100 began the month at a reading of 7312.72 and vacillated between that figure and a high of 7487 before closing July at a level of 7372 (a trading range of roughly 2%).
Likewise, the S&P500 in the USA fluctuated between 2409 and 2477 (a trading range of circa 3%) before closing the month at 2470.
The Nasdaq has been the main focus of real gains thus far this year but it, too, is caught in a slightly wider trading range of between 6000 and 6425 and it closed July at 6348.
On 31st July 2017 the FTSE100 closed at 7372(a rise of+ 0.81% for the month) and now stands at +3.21%forthe 2017 year to date. By comparison the Quotidian Fund’s valuation at the same date shows an increase for the month of July of +0.74%and for the 2017 year to date the Fund is now up+31.39%.
The technology sector in the USA has turned lower following Amazon’s disappointing latest results and the healthcare and pharmaceutical sector is still weighing up the continuing failure of Trump’s administration to repeal Obamacare. The market generally might also come to see that failure as a proxy for Trump’s other economic plans and in particular his aim to make sweeping changes to the US tax system.
Also in America the second quarter results seaon is in full swing and has not been particularly impressive thus far. Just over half of the S&P companies have now reported and, whilst earnings have been robust, sales have largely been weak and lower then expectations.
Just as an example of current equity unpredictability, in the early part of one trading day towards the end of July the share prices of many of those organisations which comprise the healthcare and pharmaceutical sector were marked up by 5% across the board. By close, however, they had all retreated to close at circa 2% down. All very disquieting and an elephant trap for the unwary.
We continue to be happy to sit out of equity markets until the picture becomes more clear.
In the UK, the government’s announcement in July that the sale of petrol and diesel cars will be prohibited after 2040 will, if true, eventually have a negative effect on oil companies, automotive and parts manufacturers and dealers. In place of fossil fuel propelled vehicles we are all expected to be driving electric cars in the future.
The fundamental motivation behind this policy announcement is the EU’s formal committment to cutting carbon emissions by 60% by the year 2040. Alice is indeed safely in Wonderland and we live in the best of all possible fantasy worlds.
Given that this embargo is still 23 years away, though, there is plenty of time yet for this policy to mutate (in much the same way that diesel car owners have experienced a roller-coaster ride as successive governments have gone from one extreme to the other in the past ten years about the level of carbon emissions from these vehicles). For diesel owners to now be threatened with prosecution and financial penalties simply for having had the good grace to follow official government advice is beyond parody.
The real-world implications of this drive to eliminate fossil fuels as our main source of energy have not yet sunk in with our current leaders in Europe nor the erstwhile political elite in the UK. Of course, they see renewable energy as a universal panacea and so turn a Nelsonian eye to the real facts; others see beyond the propaganda and tend to be more pragmatic, seeing complete reliance on wind and solar energy as a universal fallacy.
The basic question yet to be seriously addressed is simply where all the additional electricity to charge these electric cars is going to come from (and that is before we account for the government’s plans for us all to switch to electricity for cooking and heating too from 2030 onwards).
According to Michael Gove it will come from wind and nuclear power. One official estimate suggested that it would need an extra 30 gigawatts of electricity to cater just for the mass move to electric cars. In addition, though, we will not just be changing one of our main methods of transport to electricity but also our cooking and heating needs and a Parliamentary report estimates that this will increase our electricity requirementss to 350 gigawatts.
The UK presently has 7613 wind turbines. The official estimate is that it would take another 10,000 turbines to provide an extra 30 gigawatts of electricity. However, politicians either wilfully or unwittingly continue to confuse the full capacity production of these turbines with their actual output, which is only one-third of the notional maximum simply because wind is intermittent.
Taking the real output figures achieved by wind turbines as opposed to the notional maximum, it would need 5 times the present number of turbines just to satisfy our expected transport needs, each one taking six months to install and all at enormous cost.
The nuclear option requires an even greater suspension of disbelief. To produce the additional level of electricity required would take another 9 nuclear power stations the size of Hinkley Point (which itself is not due to come on stream until 2030 at the earliest) to be built. As yet there are no plans to do so and the potential costs involved would be eyewatering.
How that can be squared that with the government’s plans to obtain all our future electricity needs from renewable energy sources is a mystery. Cloud cuckoo land is a generous understatement.
At its mid-June meeting the Federal Reserve, as had been signalled earlier in the year, decided to make a further modest uplift to US interest rates. What was not expected, though, was that its future interest-rate outlook now appears to have become much more aggressive than markets were anticipating.
In the immediate aftermath of the Fed’s announcement the US stock-market witnessed a three-day sell-off and, in particular, prices in the Technology and Pharmaceutical sectors were marked down across the board by between 3% and 5%. Within a week, however, these valuations had been revised upwards again but it was a salutary warning of potential fragility in what have been 2017’s best performing (and perhaps now overbought) sectors.
June’s UK general election had been intended to give the present Government a much stronger hand with which to enter Brexit negotiations with its EU counterparts. Sadly, a toxic combination of arrogance and complacency made even worse by a manifesto that seemed to have been written by a semi-literate (and certainly politically illiterate) child brought about the dismal result it deserved.
The final outcome has raised the very real possibility (unthinkable just a few weeks earlier) of Corbyn’s circus (with its unattractive collection of of clowns, jugglers and tightrope walkers) actually being presented with the chance to stamp their Marx on the UK economy. What a political, economic and investment nightmare that would be.
I am reminded of a quotation attrubited to Churchill but probably mis-appropriated from elsewhere: “If you are not a socialist at the age of 20 then you have no heart; if you are still a socialist at 40 then you have no brain!” A similar unattributed aphorism which is also apposite here: “The problem with socialism is that you eventually run out of other people’s money!”
Brexit negotiations therefore began with the UK somewhat on the back foot and, predictably, the EU’s opening salvo was characterised by bravura, unevidenced financial demands and simplistic threats. As ever, the EU continues to exhibit its anti-democratic and protectionist raison d’etre. The uncertainty surrounding these long-winded negotiations are likely to continue to weigh heavily on UK equity markets.
As a precursor to the G20 meeting being held in the first week of July, the Bank of England’s current governor, Mark Carney, made a presentation to a gathering of central bankers in Portugal (incidentally, the collective noun for such a group should be a constipation of central bankers). In it he asserted that the prolonged period of weak growth and weak investment is coming to an end (which, strangely, is the complete opposite of the tune he was loudly whistling just one year ago in the lead up to the UK’s Brexit referendum). It wouldn’t surprise us if this announcement is just a clumsy attempt to pave the way for an impending intention to remove or reduce monetary stimulus. That would, though, be an unpleasant surprise for the equity markets which have become addicted to a steady supply of newly printed money.
Central bankers generally (and, more specifically, Alan Greenspan in the USA) were instrumental in the genesis of the financial crisis from 2007 0nwards. In their misguided attempts to ‘manage’ (or manipulate) the global economy and by proxy global stock-markets, with their policy of near-zero interest rates and their experiments with quantitative easing they were primarily responsible for the financial depression and carnage that ensued.
Given that recent history, central bankers and the politicians who indulge and support them would perhaps be well advised to adopt the philosophy of minimal interference which has proved to be the cornerstone of high achievement and success in other walks of business and life. That may be too much to ask of those who so obviously hold themselves in such high regard as self-styled ‘masters of the universe’.
On 30th June 2017 the FTSE 100 closed at 7312.72(a fall of– 2.76% for the month) and now stands at just +2.38% for the 2017 year to date. By comparison the Quotidian Fund’s valuation at the same date shows an increase for the month of June of +4.07%and for the 2017 year to date the Fund is now up+30.43%.
The CBOE Volatility Index (VIX) measures turbulence in equity markets but it should only be seen as a guide; it doesn’t necessarily give any insight to the proximate cause of such volatility. The VIX has been steadily falling to new lows in recent weeks but, at the same time, volatility among individual sectors of the stock market — especially in tech and healthcare stocks — has been rising. There is also a growing disconnect between the sanguine forecasts on these sectors from Wall Street and what is actually happening in the US economy and its legislature.
As well as the VIX, we also look at the Citigroup Economic Surprise Index. This is simply a measure of whether economic data (GDP, jobs, unemployment, housing starts, consumer confidence, retail sales, etc.) are exceeding or falling short of expectations and this index now indicates more negative than positive surprises in the current flow of data reports.
In fact, the CES index has dropped to one of the lowest levels on record. The last time it was this low was in 2011, just before the Dow dropped nearly 20% during the summer months of that year. Of course, one shouldn’t be too pedantic with technical indicators of this sort but, given the extraordinary investment return we have achieved this year to date, we now feel it prudent to bank that gain and take stock-market risk out of the equation for the time being. Our view is that there is now more downward pressure than upside potential at the present moment.
We are concerned that the leading sector of the US stock market this year (technology) came under heavy selling pressure this month. Taking into account the relatively dismal flow of economic data, the uncertainty of Trump’s measures to replace Obamacare actually being adopted and the economic impact of the Federal Reseve’s decision to further increase interest rates (together with the prospect of yet further tightening before the end of 2017) it is only a matter of time before the Dow, the S&P and the Nasdaq move to the downside.
We therefore sold 90% of our equity holdings on 23rdJune and now sit for the time being in the relative safety of cash/money instruments. The ideal, of course, would be to buy back in to equities at lower prices than our exit point. Whether that becomes possible remains to be seen but our re-entry timing will depend upon our view of the underlying strength in the renaissance of upward momentum.
As with any typical market correction this will likely be a relatively temporary reverse before equities gather the strength to go higher again but we prefer caution at this stage before seeking to re-enter the stock-market when the prospect for achieving further gains is weighted more in our favour.
The huge income inequality between EU member nations is getting worse year by year. Annual income per capita in 2009 was:
- In Germany $41,890
- in Spain $32,412
- in Greece $29,819
- in Portugal $23,122
- In Poland just $11,454
Now the differences are even wider:
- Germany: By 2014 income per capita had grown to $47,852and it would have risen even further since then had the country not taken in over one million impoverished migrants which has had the effect of skewing and suppressing today’s figure
- Spain: By 2016 per capita income had fallen to $27,012
- Greece: By 2016 it had dropped to $18,078
- Portugal: By 2016 it was down to $19,759
- Poland: By 2016 it had inched up to $12,309
Clearly the richest European country has managed to recover well from the depths of the great Global Recession of 2008-11 but many of the poorer EU countries have continued to slide further into an even darker economic hole. It is fair and reasonable to conclude that only one country has really benefitted from the EU and the synthetic currency that is the Euro.
As a consequence of that, levels of sovereign debt remain a source of concern and pose a distinct threat to economic recovery and the velocity of it. Indeed outright default in some cases, whilst unlikely, cannot be discounted
In the UK, sovereign debt is currently running at 85% of Gross Domestic Product.
In France it is over 90% of GDP.
Ireland stands at 117% of GDP.
Italy is at 127% of GDP.
The USA’s indebtedness is 138% of GDP.
Greece sits at 158% whilst Japan is at a resounding 238% of GDP.
Of course, some nations default slyly via the slow drip-drip-drip of a long-term currency devaluation (not possible, of course, in the one-size-fits-all construct of the Euro). Others beg for a bailout from their central bank or from the IMF (de-facto default by another name) or seek to issue bonds/gilts to unwary, immature or easily pleased investors. One way or the other, the end of that road is inevitably ugly.
These figures give one pause for thought and they are one of the reasons that Quotidian continues to rely on a tightly focused portfolio which concentrates on a relatively small number of reliable, trustworthy companies.
On 31st May 2017 the FTSE 100 closed at 7485.29 (a rise of+3.91% for the month) and now stands at +0.86% for the 2017 year to date. By comparison the Quotidian Fund’s valuation on the same date shows an increase for the month of May of +2.53% and for the 2017 year to date the Fund is now up +24.38%.
The fragile nature of global equity markets was tested again in mid-May when the anti-Trump and left-wing biased media in Washington and New York contrived to create a story attempting to link Trump’s sacking of the FBI chief Comey to an alleged leaking of secret information during a meeting with Russia’s foreign minister, alleged attempts to pevert the course justice and yet another re-hash of allegations relating to supposed Russian interference in the 2016 US election (basically throwing any mud they could invent in the hope that some of it would stick).
Without waiting for anything remotely resembling evidence to emerge, the usual suspects immediately began a chorus of calls for Trump’s impeachment. We live in hope that one day soon the land of the free and the home of the brave will embrace the concept of democracy.
These allegations have all the hallmarks of a politically based stich-up and, from the paucity of evidence currently available, they do not stand up to even the slightest scrutiny. Intellectual rigour is rarely the forte of the leftist, politically correct media either in the UK or the USA (who much prefer to work on assertion, commentary and opinion). The much touted chain of incriminatory emails and supposedly damning contemporaneous minutes of meetings held in February are, as yet, nowhere to be seen. The ‘facts’ that have thus far emerged certainly do not support the media’s assertions; indeed, they chime more with the propaganda and inventions we are familiar with from Project Fear.
We are keeping an open mind. If and when real evidence of wrongdoing does come to light then we will change our views of Trump and of global equity markets.
April has witnessed further examples of the negotiation techniques favoured by Donald Trump and with which we are becoming increasingly familiar.
For the 2016 year the US trade deficit with China stood at a very substantial $347 billion. With a view to redressing this imbalance, in his immediate post-election speeches Trump accused China of chronic currency manipulation and threatened to impose a 45% tariff on Chinese imports.
However, during their meeting earlier this month China’s President Xi Jinping offered concessions for better US access to China’s financial markets and agreed to open up access to the Chinese market for American beef producers too. Clearly the US is a hugely important export market for China and so it made Trump’s deliberately heavy-handed approach more likely to bear fruit. I think it’s fair to say that, initially and on the face of it, this is a positive and promising result for Trump and his tactics.
On the other hand, Trump’s attention has now turned to Canada which is the world’s largest importer of US products and the most important foreign market for 35 out of the 50 individual US States. In fact, Canada is one of the few nations that the US enjoys a trade surplus with (exporting $337.3 billion worth of goods and services to Canada against imports of $325.4 billion); a surplus of nearly $12 billion. According to data from the US Department of Commerce, America’s exports to Canada support an estimated 1.7 million US jobs.
US-Canadian relations are quickly deteriorating, though, as Trump intensifies a trade dispute with the Canadians by foisting tariffs of up to 24% on imports of lumber from Canada. Apparently this escalating trade war is in retaliation for recent changes in Canada’s dairy policy that US milk producers claim violate the North American Free Trade Agreement (NAFTA).
Trump’s standard approach of threats followed by reasonableness is potentially less helpful when the boot is on the other foot. Given that the trade surplus with their northern neighbours is currently biased so far in the US’s favour, his administration would be well advised to consider more carefully how it proceeds to re-negotiate trade policies with the likes of Canada. History shows that ‘protectionism’ in any form simply leads to unhelpful tit-for-tat trade wars which ultimately benefit no-one at all (a point that the EU bureaucrats would also be wise to heed).
On 30th April 2017 the FTSE 100 closed at 7203.94(a fall of-1.62% for the month) and now stands at only +0.86% for the 2017 year to date. By comparison the Quotidian Fund’s valuation on the same date shows an increase for the month of April of +5.54%and for the 2017 year to date the Fund is now up+21.29%.
April has seen yet another resurgence of how European stock-markets in particular are still in thrall to political issues rather than simply to economic concerns.
In the UK, on 19thApril Theresa May surprised markets by announcing a snap General Election to be held early in June. Markets were caught entirely on the hop and have largely reacted in a negative fashion simply because they dislike uncertainty. Whilst the outcome of this election is a foregone conclusion and will certainly strengthen the UK’s hand in negotiations for Brexit, markets are likely to remain subdued and in a narrow trading range until the voting is over and the result confirmed.
The second round of the French presidential election was held on 23rdApril. The first round last November had produced an apparently decisive lead for Francios Fillon, the middle-right Conservative candidate, and running second was Marine Le Pen, the far right Nationalist nominee. Both of these contestants are determinedly anti-EU. However, following a concerted media-led and politically motivated campaign to discredit Fillon and promote Emmanuel Macron, a pro-EU entrant who had finished a distant third in the November primary round but was heavily favoured by the Brussels bureaucracy, the second round saw Macron pip Le Pen (both of whom now go on to contest the final round on 7thMay) whilst Fillon was a close up third and thus knocked out of the race.
Initial stockmarket reaction was very positive but illogically so. Markets across Europe rose by 4% on 8thMay as if all the economic ills of France (and indeed of the EU) had disappeared at a stroke. Economic reality will reassert itself to European equity valuations soon enough.
The relevance of all this is that Macron is now the strong favourite to prevail and become the next President of France; he has already made it clear that he will not make the Brexit negotiation process a straightforward or reasonable one and whilst Brexit still remains a focal point of investor’s concerns in the UK it is likely to continue to be the cause of short term volatility.
Elsewhere, and on a more positive note, Trump’s much heralded tax reforms in the USA have now been tabled and will go through the legislation process early in May. The intention is to cut Corporation Tax from 35% down to 15%, to radically simplify the labyrinthine system of US Income Tax into just three simple rates of tax (10%, 25% and 35%) with more generous tax reliefs, and to repeal the death tax (the US version of Inheritance Tax).
There is abundant historical evidence to support the case that such reductions and simplifications actually have the effect of increasing the overall tax-take (the concept known as The Laffer Curve). Not least, Trump’s new proposals are designed to encourage those US companies who currently avoid paying tax in America by establishing their tax domicile elsewhere, to return home and make their contributions to Uncle Sam.
Likewise, by putting more discretionary income into the hands of US consumers, there will be an increase in the tax revenue via the US Sales Tax (essentially their version of VAT) as that money is spent.
Despite that, the usual anti-Trump voices have already been raised in protest against this new tax system and it will no doubt have a rough ride through the House of Representatives and the Senate. It seems that anything to denigrate Trump is the prevailing theme in Washington and if that means ignoring any supporting evidence in his favour in order to criticise and frustrate positive progress then so be it.
Ultimately, though, I do think the new tax system will be adopted (in part if not in whole) and the expectation of such positive tax reform has been one of the drivers of the recent US stockmarket ebullience. In some eyes, Trump still remains a figure of fun but there is no doubt that since he took office equity markets in the USA have been and continue to be very positive. Long may it continue.
During March three significant events caught the attention of equity markets. The first of these was the well-heralded uplift in US interest rates announced by the Fereral Reserve following its mid-month meeting. As expected, this increase was of 0.25% and simply reflects the developing strength of the American economy as it continues to emerge from the dark days of the global financial crisis.
The important point to reiterate here is one we made in last month’s report. That is that the Federal Reserve tinkers with just short-term interest rates which, in the overall scheme of things, are relatively inconsequential. In terms of equity market performance the much more relevant rate of interest to watch is that on the 10 year US Treasury Bond. At the start of this year that yield stood at 2.45% and by 31stMarch it had fallen even further to 2.40%.
The dividend yield on the S&P 500 is a smidgen above 2% which, by comparison, makes investment in US equities a much more attractive proposition than watching the real value of one’s capital inexorably decline in bonds (Treasuries and gilts). Despite the element of risk inherent in stockmarket exposure, the shrewd element of the investing public has cottoned on that assertion. In our view, growth in corporate dividend payments coupled with capital appreciation in the medium and long term from a portfolio of well chosen equities is the best way forward.
Secondly, President Trump suffered his first major defeat when his attempt to repeal ‘Obamacare’ was rejected by the US legislature. It would seem that a number of his fellow Republicans voted against their Commander-in-Chief not because they thought Trump’s plan was too extreme but because it did not go far enough! Stockmarkets reacted badly and we endured four successive days of declining valuations.
The triggering of Brexit eventually took place on 29thMarch after a gestation period of 9 months (quaintly, the same average gestation period as the tortoise*). Article 50 was invoked by snail mail with a letter from Theresa May being hand delivered by our man in Brussels to one of the multiplicity of EU Presidents.
Whilst exit negotiations will, no doubt, be deliberately difficult and long-winded we believe that the final outcome will be of great benefit to the UK and its successful economic development. Simply emoving the extraordinary burden of piffling, unnecessary EU regulations will allow the British economy to escape from the constipation of petty bureaucracy and prosper.
On 31stMarch 2017 the FTSE 100 closed at 7322.92(a rise of+0.82% for the month and now stands at +2.52%. for the 2017 year to date). By comparison the Quotidian Fund’s valuation on the same date shows an increase for the month of March of +1.64%and for the 2017 year to date the Fund is now up+14.93%.
Despite the negative market reaction to Trump’s setback with Obamacare the Quotidian portfolio continued its upward momentum. The real engine for recent stockmarket growth in America has been the President’s promise of tax reform and we have little doubt that Trump will succeed in getting his restructuring of the US tax system passed by the House of Representatives and the Senate.
It is inherent in the character of stockmarkets that there will, no doubt, be a correction before this year is out. However, that will be a pause for reflection before another move higher.
It is worth noting that in the past 25 years there have been declines of more than 10% (and, on occasion, two or even three such declines) in each and every year. Nevertheless, in 17 out of those 25 years the market has still ended the calendar year in profit.
The Quotidian Fund comprises a core portfolio of high quality growth stocks and so we believe that we are well set to weather any short-term corrections.
One month into Donald Trump’s tenure and a clearer picture of the man and his methods is emerging. Unlike generations of politicians before him, his determination to fulfil his pre-election promises is already apparent and his actions so far are having a palpable positive effect on the US economy and its stockmarkets.
We mentioned in our January report the beneficial effect of lower taxation (both corporate and personal), less regulation and the creation of more jobs; Trump has made positive progress in each of these areas. In particular, corporate taxes take a huge bite out of a company’s cash flow and profits. Trump has committed to lowering corporate tax rates and creating incentives which will encourage companies to keep their operations in the US and to hire US citizens (who, of course, would also be US personal taxpayers).
As a result, companies are now more likely to reinvesttheir tax savings in order to grow their businesses. This would allow them to take on more (and better-trained) employees, improve their infrastructure and technology use and capture greater market share.
During Trump’s first day of actual work as President he met with representatives of many of the largest companies in the USA. At that meeting he emphasised that he would cut business regulations by 75%. Freed from the burden of more and more complicated compliance regulations (and the ever increasing numbers of non-productive staff needed to cope with them) this is a huge boost to American business. Even if he ultimately ends up cutting existing business regulations by only 30% that would still provide businesses with the capital to hire more productive workers, to expand growth and thus to generate greater profits for shareholders.
In particular, at a meeting with the CEO’s and senior executives of major companies in the biotech and pharmaceutical sector (following an initial plea for lower drug pricing which was mere rhetoric and window-dressing) he confirmed that he was reducing the enormous burden of regulation that had been increasing imposed by his predecessor and that had become a constipation to research and development as well as to profits.
New medicines and drugs will now achieve FDA approval much more quickly and thus generate cash-flow and profits to the conceiving company in a much shorter timescale. Whereas in the past it could have taken, in extremis, as long as 13 years for a new drug to be approved, that approval process is now expected to be no longer than 4 years. The impact on share valuations in this sector has been dramatic and the dark cloud hanging over it under the last 18 months or so of Obama and Hilary Clinton’s inept stewardship has cleared.
Since Trump was elected last November the Dow Jones Index has risen by over 10%and held above the technically significant 20,000 level whilst the S&P500, the Nasdaq and the Russell 2000 index (which measures Small-Cap stocks) have also reached all-time highs. This has demonstrably been a very broadly based uplift in US equity markets.
Now that he is established in office and by judging his actions thus far simply from an economic perspective, we believe we are on the cusp of a period of economic growth in the United States that hasn’t been seen in decades. And as a direct consequence of that, as the USA economy expands then there will be a beneficial knock-on effect to the global economy.
Aside from the economic reasoning outlined earlier in this report, our optimism is based on one market statistic that has been a fundamental factor behind the US stockmarket’s move higher and that factor is the yield on 10-year US Treasury bonds. This yield rate has an influence on returns across the entire global financial market not just in the USA.
At the start of 2017 the 10-year US Treasury yield stood at 2.45% and despite the uplift in US equity valuations it has barely moved since. This means that current 10-year US Treasury buyers (of which there are few) are exchanging their investment capital for an annual yield of just 2.45% and the return of their original investment ten years from now with no hope for growth in either the coupon payment or the original capital investment (no more, no less) being returned at the end of their 10-year holding period. We have often described investment in Treasuries (or gilts in the UK) as return free risk and this is a perfect example to illustrate that point.
Now if we compare the 10-year Treasury return to the S&P500. With the dividend yield on the S&P500 hovering around 2%, investors committing their capital to that benchmark US stock index will receive a regular dividend payment of about 2% annually and, more importantly, the prospect of future growth on both that dividend payment as well as their capital investment. Growth in the dividend payments as well as potential appreciation on the capital invested is a powerful combination.
Growth (in the equity environment) versus No Growth (in the bond environment). No wonder that long-term investors are increasingly choosing to opt for growth and that is what is driving stock prices higher.
Even if interest rates are, as expected, pushed marginally higher by the Federal Reserve during 2017 it will only affect the short-end of the yield curve and not the 10-year rate.
With this scenario unlikely to change in the foreseeable future we are of the strategic view that we stay in stocks and shares until the 10-year bond yield moves higher. If and when that 10-year bond yield noticeably changes then we will change our minds.
Of course, equity markets cannot and will not continue upwards at their recent breakneck pace and so we expect to see a typical stock market correction (to allow share prices to draw breath before moving higher again); that eventuality will be a buying opportunity rather than a panic to the exit doors.
2016 was an investment year when political considerations rather than economics dominated global markets. Whilst the main indexes in both the USA and Great Britain ended the year in positive territory, those indexes do not act as a proxy for the wider market. Both the Dow Jones Index and the FTSE100 are weighted indexes and are biased in such a way as to largely reflect Oilers, Miners, Financials and Telecoms as opposed to the middle and smaller sized companies which better indicate the overall economic health of a country.
With the induction of a new President in the USA, the imminent initiation of Brexit negotiations and forthcoming elections in the three largest economies of the Eurozone (Germany, France and Italy; and which seem likely to further diminish the waning power of the EU), we expect 2017 from an investment viewpoint to be in thrall to politics too.
However, we also believe that there are some notably positive economic influences and improvements that will help to propel the US economy forward and, by osmosis, the UK and selective parts of the global market too.
We draw support for that assertion not from the bombast but from the initial actions of the newly installed President Trump. In his pre-election rhetoric the new President committed to making a number of fundamental economic changes and in his early days in office he has begun to make good on those promises. Beneficial modifications already include:
Less regulation: Obama, in his two relentlessly un-achieving terms in office, imposed countless new regulations on US business that only had the effect of stunting corporate growth. In the early days of January the Republican-controlled Congress moved aggressively to repeal a series of Obama regulations and in the immediate aftermath of his inauguration Trump has lifted many more simply through a series of executive orders. This process of freeing the US economy from stifling bureaucracy will no doubt continue.
Lower taxes: The eight years of Obama’s administration saw the imposition (and continuation) of some of the biggest tax burdens in the history of the USA both on US citizens and on businesses.
Not only federal and local income tax rates that extracted as much as halfof an individual’s annual income but also sales taxes, capital gains taxes and death duties. On top of all that were ‘stealth’ taxes in the form of increasingly high health insurance premiums. So much for Obamacare.
According to the non-partisan Tax Foundation, US workers had already had to suffer a 31% tax burden even before they came to pay income tax. Trump will be the first American president since Reagan to introduce tax cuts. He will also replace Obamacare and so greatly reduce health insurance costs.
More jobs: Trump has committed to creating many more new jobs in those parts of America that have suffered most from chronic lack of investment and outdated industries. We have little doubt that he will fulfil that pledge.
The benefits of Trump’s actions (rather than his oft and easily criticised ‘media personality’) can already be seen. According to a recent University of Michigan survey just the prospectof these tax changes has boosted US consumer confidence to a 13-year high. Thus, even before the real impact is felt on corporate profits, the positive psychological impact is already sweeping through the US economy and its financial markets.
It all points to radical change in the US landscape; a seismic shift of epic proportions in the economy and in the investment markets. Unshackled from onerous government interference and freed from the suppressive effects of high taxation the US economy should now improve substantially.
“What a man thinks and what a man says is of no particular note. The only thing of importance is what a man does”. An old aphorism that we keep in mind when sizing up Donald Trump.
He is a man who, on superficial judgement, is easy to deride and underestimate. A long-term associate of his believes that Trump has succeeded because his opponents miss his message when they take him literally but not seriously. His supporters do just the opposite and so have shared in his success.
Time may prove otherwise but until then we believe in ignoring most of President Trump’s controversial actions and ‘tweets’ and focusing simply on what he actually does. From his actions thus far we are persuaded that the promise of strong economic growth in the USA will be fulfilled (and, by extension, that will benefit the global economy too).
At the end of January Trump went on record with theWall Street Journalsaying that the dollar is too strong. He went on to assert that the value of the dollar is too high (partly) because China manipulates the value of its currency lower. That situation has been rather obvious for quite some time.
But currency manipulation does not only apply to China; the Bank of Japan has for years been manipulating the yen lower against the US dollar and every other nation on the planet does exactly the same thing by periodically marking down the value of their currencies too in order to secure a competitive advantage for trade.
The European Central Bank is also doing everything in its power to water down the value of the euro. Of more economic relevance, the eurozone’s growth rate in 2016 rose to the dizzy heights of 1.6%. The depressing fact is that this paltry number is actually still double the average EU growth rate over the previous ten years. Will they ever admit that the ‘federal Europe’ experiment has been a dismal failure?
Perhaps Trump will shortly amend the notice famously kept on the President’s desk in the Oval Office so that it will quite simply read “The buck drops here.”!! We are sure that ideally he would like to weaken the dollar partly in order to make US exports more competitive and partly so that the US can repay with a weakened currency the enormous debt mountain built up under Obama’s spendthrift stewardship.
However, Trump’s plan to lower corporate tax rates is very likely to trigger massive capital inflows into the dollar as US multinational companies seek to take advantage of lower tax rates to repatriate profits earned and held overseas. Whilst that may hobble any desire to weaken the dollar, history shows that such incoming money invariably moves into and boosts the stockmarket.
At the risk of stating the obvious 2016 was been a challenging investment year and the counter-intuitive nature of the year started with a very substantial downturn in global markets on the very first day of trading. Within the first weeks of January that markdown in equity valuations around the world had reached a fall of 15% in trading conditions that were starkly reminiscent of the height of the global financial meltdown in 2008.
Since those darkest days of the global recession it has been a long, slow and stutteringly hit-and-miss recovery with regular setbacks revolving primarily around slow global GDP growth (which, in turn, have been caused by an over-indebted world and systemic demographic issues).
Following January’s awful start to 2016 it took until May for the Quotidian Fund to recover to more or less an even keel and then, in the lead up to the UK referendum and the weeks following the Brexit vote, markets went over a cliff for a second time. By September we had again recovered most of the lost ground but the latter part of October saw yet another double digit sell-off.
We have seen these market conditions before and are familiar with the necessary management of them. Over the past 25 years there have now been 20 similar occasions when global equity markets have fallen by more than 10% in a relatively short period of time (the most recent of these being in October 2016).
After that October markdown we again found ourselves in an almost identical situation as we had been following January’s market downturn and that we revisited after the further sell-off in June. However, by late September/early October we had recovered all the value ceded in June’s downturn and we knew very well that the situation was again one for calmness and cool heads until the storm passes. We fully expect the markets and our performance to recover its ground yet again in a relatively short timespan; what we see just now is simply a temporary paper markdown not an actual crystallised loss.
On 31stDecember 2016 the FTSE 100 closed at 7142.83 (a rise of + 5.29% for the month and +14.43% for the 2016 year). By comparison, the Quotidian Fund’s end of year valuation shows an increase for the month of December of + 1.30% and for the 2016 year overall the Fund was -13.99%.
It is pertinent to note that during the recent US stockmarket rally five stocks have accounted for over 60 percent of the uplift in the Dow Jones Index. In other words, roughly two-thirds of this latest rally in the Dow can be attributed to just these five companies: Goldman Sachs Group, UnitedHealth Group, JP Morgan Chase & Co, Caterpillar Inc, and Boeing Co.
And of these, one company has stood head and shoulders above the rest during this post-election upturn: Goldman Sachs. In fact, the upward re-rating of shares in this investment firm alone have been responsible for 30 percent of the uplift in the Dow Jones Index. The other four shares combined make up another 30 percent.
The point I am making here is that the apparent increase in the DJ index is superficial and narrowly based, as indeed is the similar rise in the FTSE 100 index. On closer scrutiny these increases in index levels are confined to a relatively small number of companies which are driving the headline index forward whilst the wider market (and, in particular, the mid-cap and smaller companies) currently remain relatively turgid. However, there are increasingly positive economic signals from both the UK and the US and it is only a matter of time until these demonstrably more upbeat monetary figures and improved economic confidence cascade through to the wider reaches of the stockmarket.
Evidence to support that view includes:
- The recent pick-up in economic data (including improving unemployment and income numbers, increased consumer confidence and spending statistics and increasing home-sales figures).
- The positive uplift in S&P 500 (ie. the wider market) profits and earnings in the last quarter.
- Prospects for less business regulation, lower taxation and greater fiscal stimulus under President Trump.
Ironically, however, the Fed also forecast four more interest rate increases in 2016 and, despite the fact that this is the one area it has most control over and the one that investors count on the most, it got that future ‘guidance’ hopelessly wrong. The recent mid-December increase was actually the one-and-only US rate rise in 2016.
Generally speaking, higher interest rates lead to lower stock market valuations and, after that December 2015 rate uplift, equities suffered a severe adverse reaction at the very start of 2016 with the Dow plunging about 2,000 points until the market eventually bottomed out in February.
In its recent statement following this December’s interest rate increase the Federal Reserve signalled a faster trajectory of interest rate increases during 2017. Historically, though, its forward guidance projections have consistently been so far wide of the mark that we see no reason to overreact to this latest assertion.
In the UK, the 20% drop in the value of the pound against the US$ and most other major currencies since the Brexit vote has made UK Manufacturing highly competitive in the short term. However, UK Manufacturing is just a relatively minor part of Britain’s economy and the very same depreciation in the currency that has helped manufacturers could cause prices to spike for most UK consumers (who rely on the importation of many key goods). The ongoing uplift in the UK economy and its wider stockmarket through 2017 will be reliant on the continuing ability of UK consumers to maintain upward momentum in their demand for goods and services.
One of the quirks of the US presidential election system is that there is a long inter-regnum period between the outgoing president actually departing and the president-elect assuming office. Despite the fact that we have known the recent election result since 9thNovember, Trump does not take over the reins until 22ndJanuary and so markets are effectively in a period of limbo.
In the days immediately following the outcome of the election the US stockmarket (and especially sectors such as biotechnology and pharmaceuticals) soared upwards but it has since been treading water and in the doldrums. As ever, the US is mimicked by world markets. Until the present vacuum is filled by Trump’s eventual accession, equity valuations are seemingly being based upon conjecture and guesswork.
In the meantime, Obama is yesterday’s man and now spends his time on a valedictory world tour cementing the hallmark of his tenure as being a period of impressive oratory but very little effectiveness or achievement; honeyed words not matched by action. Under his stewardship the US national debt has more than tripled and now stands at $19.8 trillion. Worse still the Committee for a Responsible Federal Budget expects a further $4.6 trillion of debt to be added over the next 10 years as the long-term effect of Obama’s financial incontinence.
With a sense of optimism that turns a blind eye to hard economic reality the US government hopes to fund that deficit through a huge increase in the supply of Treasury bonds. However, there is just a little problem with this fanciful sanguinity in that investors are becoming ever less willing to lend money at parsimonious yield rates to spendthrift governments.
In the week after Donald Trump‘s election victory investors withdrew more cash out of US fixed-income funds than at any time over the last three years. Foreign governments had already been selling US Treasury bonds hand-over-fist ahead of the presidential election. This is highlighted by Treasury International Capital (TIC) data released last week that showed the liquidation trend already firmly entrenched in September.
For example, China holds a mind-boggling $1.157 trillion in US Treasury securities (the second largest holder on the planet) and they’ve been selling those Treasuries to fight against yuan devaluation. They have plenty of inventory left to sell as they contend with capital flight and a pullback in trade. The sell-off thus far from this source could just be the beginning.
Saudi Arabia is another heavy seller of US Treasuries. In fact, they’ve liquidated nearly one-third of their Treasury holdings since the start of the year. With its income from oil diminishing greatly as the price of oil has declined, we are likely to see even more selling.
The good news is that with everyone selling bonds, that money is looking for a place to land and historically that landing site has inevitably been the US stock market. The fact is that many US blue-chip companies have stronger balance sheets than most national governments and are a palpably safer place for capital investment. In our view this will propel US stocks much higher in 2017. The Dow Jones index has closed and held above 18,500 already this month and, from a technical perspective, that will validate the next move higher.
On 30thNovember the FTSE 100 closed at 6783.79 (a fall of –2.45% for the month and +8.67% for the 2016 year to date). However, the mid-cap and small-cap indexes have still not performed nearly so well thus far this year.
By comparison, the Quotidian Fund’s current valuation shows an increase for the month of November of +2.42% and for the year to date the Fund is now -15.10%. The Fund’s monthly uplift was much better than that until a 3% across the board markdown on the last trading day of November temporarily took some of the shine off. Yet again this markdown was based entirely on political speculation and has nothing to do with economic common sense.
On the immediate horizon there are three issues of market-moving potential. One of these issues is economic and the other two are political:
Throughout 2016, despite market rumours to the contrary, we have consistently pinned our colours to the mast in terms of US interest rates by repeatedly stating our belief that the next increase in rates will be made at the Federal Reserve’s meeting in December. We still expect, with a degree of confidence, that the Fed’s mid-month meeting will deliver a small increase of 0.25% to US interest rates. That should not disturb market sentiment although it would not surprise us to see a short-term flurry of negativity; it is in the self-interest of market makers to create uncertainty in the certain knowledge that it will cause some investors to panic and sell their holdings. Strangely, and to the sole benefit of the market makers themselves, those same investors will buy back in at higher prices once they feel ‘safe’ again.
The primary elections towards appointing a new President in France are under way and there has been a palpable move to the right of centre politically. The country’s left wing is fragmented and in complete disarray; Hollande is rapidly heading for the exit door and the velocity of his departure will be facilitated when he fails to win the socialist primaries in January. It is highly probable that the final outcome will be fought out early in May between Francois Fillon (moderately right of centre) and Marine Le Pen (far right). Both of these candidates are Eurosceptic and the result will certainly disturb the complacency and self-satisfaction of the EU apparatus in Brussels.
Long before that denouement in France, on the first Sunday in December the Italian referendum will determine the fate of their current Prime Minister (Matteo Renzi, who brought a socialist and pro-EU agenda into office with him). Renzi’s Government has implemented numerous reforms including a relaxation of labour and employment laws with the intention of boosting economic growth. None of this has had the slightest positive effect on the Italian economy or its lamentable unemployment rate and euro-scepticism in that country is rampant. Whilst the referendum is not directly concerned with the euro or Italy’s membership of the EU, the outcome will have a profound effect on both of these issues. If the ballot delivers a ‘no’ result (as seems a foregone conclusion) then it will further shake the foundations of the EU and the future of the euro in much the same way as Brexit did.
The Eurozone remains dysfunctional. There is no fiscal union, no political union, no shared debt nor genuine banking union (all of which should have been essential precursors to the launch of the Euro). Even the Euro’s founding economist (Otmar Issing) has now disowned it. His comment on 16thOctober that “one day the house of cards will collapse” is telling indeed. His implication was that this fateful day would be sooner rather than later. Our view is that the EU in its current form will implode under the weight of its own hubris by 2021 at the latest.
For the third time this year investor’s patience was put to the test in October by yet another period of relentless negativity in global stockmarkets. From 7thOctober onwards equity markets were marked downwards day after day with just the occasional pause for breath. Whilst the FTSE100 retained a mythical level of serenity, the mid-cap and smaller companies end of the UK market took another hit and negative contagion spread through all the major world markets.
The trigger point was attributed to Theresa May’s keynote speech to the Conservative Party conference following which the term ‘hard Brexit’ was invented. Of course, Mrs May did not coin that phrase nor did her speech make any aggressive reference or intent towards forthcoming negotiations with the EU. Quite the reverse in fact. What she actually said was quite benign:
“The Britain we build after Brexit is going to be a global Britain. Because whilst we are leaving the European Union, we will not leave the continent of Europe. We will not abandon our friends and allies abroad and we will not retreat from the world”.
However, as is becoming ever more blatant and ever more tedious, the ‘hard Brexit’ phrase was created by those with an axe to grind and vested interests to serve (either commercial or political) in newspapers to sell, television schedules to fill and fear, discord or nuisance to stir up. As a result, equity markets around the world were rattled.
Simultaneously, and adding fuel to the prevailing negative tone, the third quarter earnings season also began this month and analysts were quick (much too quick) to predict profit declines based on a very small sample of early results. After just a handful of early reports (from less than 5% of the entire S&P500) had been disappointing Wall Street analysts pressed the panic button and simply extrapolated those early negative releases as a template for the entire earnings season.
As their past performance indicates though, market analysts generally and Wall Street analysts in particular have a near-perfect track record of missing the point. They continually underestimate actual results and are often way off the mark with their forecasts. Despite that, they do influence the short-term direction of stock market valuations.
Towards the end of October that assertion on the efficacy of analysts gained credence and support from a surprising quarter. In a statement on 25thOctober the Governor of the Bank of England, Mark Carney, acknowledged that current market action may be based on ‘mistaken’ analysis of the state of the economy. Such an admission from one of the leading lights of Project Fear is most welcome and better late than never.
In fairness, corporate management also contributes to the forecasting problem in that it has a tendency to under promise and over deliver and so analyst’s estimates are frequently too pessimistic. Companies and the analysts who cover them effectively “conspire” to set the bar too low in order that companies can surpass it with positive earnings surprises and so keep shareholders happy. Equity valuations that have been artificially suppressed then rise again to more realistic levels when actual results turn out to be better than dubious expectations.
In fact, over the past four years actual corporate results have, on average, beaten analysts estimates by 4.3% according to research by FactSet. And so it has proved again this year as the results season has progressed through October. As I write, 61% of the S&P500 results have now been released and, of these, 78% have produced positive upside earnings (profits) surprises. Thus what has been marked down on unjustified low earnings assumptions and self-fulfilling pessimism must come up again on the reality of higher actual results. There is good reason for optimism that these better than expected earnings will now be reflected in a belated but warranted uplift in share valuations.
Lurking in the background and adding to the October gloom has been the US Presidential election, now entering its finishing straight. Markets abhor uncertainty and although in recent weeks the contest seems to have swung towards the Democratic party there is still a very real possibility for the result to reflect the opposing views held by very many disaffected Americans living outside the left-wing ‘bien pensant’ and media-savvy bubbles of New York and California.
On 31st October the FTSE 100 closed at 6854.22 (a rise of +0.80% for the month and +11.40% for the 2016 year to date). However, the mid-cap and small-cap indexes have not done nearly so well thus far this year. Many of the companies in the Footsie index have a substantial part of their earnings denominated in US dollars or Euros and so have benefited from the depreciation of the pound since the Brexit vote. This is a currency-driven short-term boost simply because the pound is trading on politics not on the economy at the moment. By comparison, the Quotidian Fund’s valuation at the same date shows a markdown for the month of October of -10.06% and for the year to date the Fund is now -17.11%.
US capital markets are still considered the most liquid and safest markets on the planet and that is why our portfolio has a major bias towards the American markets. Although the Federal Reserve is likely to raise US interest rates in December (if for no other reason than just to save face) the Fed is not going to tighten nearly as much after that as the market currently seems to think. In our view it could be another six to nine months into 2017 before they move on rates again. The fact of the matter is that the global economy is just not strong enough yet to absorb a normal round of monetary tightening at this stage.
On a lighter note we have been amused by the childish posturing of various politicians in Europe who are trying to give the impression to their own people that negotiations with the UK on Brexit will be tough and uncompromising. Of course, neither Merkel nor Hollande will still be in office when the real negotiations are in full swing next year.
The suggestion by one Eurocrat that negotiations will only be held in French was particularly laughable. I understand that discussions are now taking place to employ Brian Blessed to lead the UK’s negotiating team in order that we at least have someone to shout loudly at them in English!
Finally, I am obliged to two professors at the London Business School for research going back as far as 1955. It shows that investing in UK smaller companies over the past 60 years has achieved an annual return of 15.4%. That, of course, is why we also focus a large part of our efforts in the small caps area.
There is a catch, however (and a rather obvious one). Although this performance track record over such a long period is very attractive (and the sector tends to be overlooked by the majority of investors) the 15.4% return did not, of course, come smoothly year after year. In some years’ smaller companies powered ahead by 30% or even 40% but in several other individual years between 1955 and the present day they also fell by similar amounts. As we all appreciate, volatility is inherent in equity market investment; it’s the overall medium to long result that counts.
Falls of this magnitude so often cause private investors holding UK small caps to make the mistake of giving up in fear, crystallising their 30-50% loss and then never investing in the stockmarket again. This is a much more costly error than enduring periods of volatility.
We invest in good, reliable companies and hold them through these market cycles (often building up our holdings at attractive low prices). We are long on stoicism and strongly believe in the proven benefits of riding out periods of volatility and times when temporarily muted valuations have been based on institutional group-think and over-pessimistic analysis. Patience is particularly relevant in this current period of lacklustre investment returns.
Global stock markets were relatively quiet from mid-July through to the end of August. In fact, the S&P 500 went for 43 trading days without moving more than 1% in either direction. However, that period of relative calm was decisively broken in the early part of September as the S&P 500 plunged 2.50% on Friday 9th, rebounded 1.50% on Monday 12thand then again plunged another 1.50% Tuesday 13th.
There was no actual economic reason for this renewed turmoil. Wall Street just loves to engineer investment volatility and sometimes take it to uncomfortable extremes. Market makers like to keep the fear factor at the forefront of non-professional investor’s thinking and thus provoke the unwary into selling when they should hold fast (and let buying opportunities pass when they should be filling their boots). In this latest burst of volatility all major asset classes saw declines. As ever, Wall Street bangs the drum and global markets march to the same tune.
In theory, stock and bond prices move in opposite directions from each other; when share prices decline bonds rally upwards and vice versa. Too often for comfort that old truism does not persist in today’s markets. One of the consequences of the financial crisis has been that much conventional economic thinking has been turned on its head. Thus we see that supposedly non-correlated asset classes frequently now all move in the same direction whereas in times past they counter-balanced.
In practice it has always been true that stock, bond, commodity and currency markets are influenced by the actions of central banks. In recent years, however, that influence has reached new extremes as a direct result of endless political tinkering and central bank intervention. This has created an unhelpful addiction to financial stimulus which, in turn, has the effect of illogically distorting asset prices across all the main asset classes. It can be compared to giving £10 to a drunkard; you know what he’s going to do with it but you just don’t know which wall he’s going to use! These frequent and unpredictable bouts of volatility will only stop when politicians stop interfering and simply allow markets to price assets on the basis of economic reality.
A few months ago the Bank of Japan (BoJ) decided that it would take the ultimate monetary policy action (and a step into the unknown) by taking short-term rates into negative territory. Seemingly the thinking (if one can call it that as opposed to guesswork) was that Japanese banks would thus be forced to lend out money rather than see the value of that asset depreciate on their own books. However, like many market manipulators before them, the BoJ did not anticipate the unintended consequences of their action. Negative short-term rates drove rates on longer-term bonds into negative territory too and so banks (who make most of their profits by borrowing short and lending long) saw their profits evaporate. With diminishing profits, banks’ lending standards perversely became even more stringent; they thus lent even less than before and ended up with the greatest hoard of cash in Japanese history. This, of course, was exactly the opposite of what the BoJ had intended.
On September 21stthe BoJ essentially admitted defeat when it announced that it will no longer practice standard quantitative easing (QE) but instead would focus on yield targeting. It still intends to buy Japanese bonds and stocks but will now ensure that the yield on the benchmark 10-year Japanese Government Bonds remains above zero. In short, the BoJ asserted that there was “no limit” to their willingness to keep 10-year rates above zero. We’ve heard that sort of rhetoric before but invariably it’s a typical politician’s empty promise.
Through its actions the BoJ is effectively nationalizing the Japanese stock-market. From figures compiled by Bloomberg, by the end of 2017 the BoJ will be the largest shareholder in 55 of Japan’s largest companies.
Meanwhile, both the Bank of England and the European Central Bank have announced massive asset and corporate bond buying programmes too and seem to be following the same road as the BoJ.
Observing that situation with a cynical eye, conventional pricing mechanisms are in danger of being swept away by this tsunami of newly printed money and, with governments becoming the largest shareholder in such a substantial number of major businesses, the scope for market manipulation is becoming a cause for concern.
On 30thSeptember the FTSE 100 closed at 6899.33(a rise of+1.15%for the month and +10.53%for the 2016 year to date). However, the mid-cap and small-cap indexes have not done as well thus far this year. By comparison, the Quotidian Fund’s valuation at the same date shows an uplift for the month of September of +1.17%and for the year to date the Fund is now –7.82%. We continue to claw back the ground temporarily ceded during two substantial global market downturns earlier in the year and, with three months of the year remaining, I remain confident that we will be nicelyinto profit for 2016 by the year end.
We have been following with wry amusement various ongoing arguments between the USA and the European Union, which have accompanied their 10 year negotiations in search of agreement on a trade deal. These have come to a head during September.
To gain perspective, it is worth comparing and contrasting the historical background to the trading and business styles of each of these blocs.
The US approach to international trade can best be understood through the philosophy expressed some years ago by John Connally when he was their Treasury Secretary. He said that “All foreigners are out to screw us and it’s our job to screw them first”.
From the other corner, the EU is and always has been protectionist, anti-capitalist and anti-business (think Jeremy Corbyn on performance enhancing steroids). The latest salvos give one an even better insight into the workings, beliefs and motives of the EU.
At the end of August the EU attempted, through the sly medium of instructing Ireland to collect the sum demanded, to impose an eye-watering ‘fine’ on Apple for what was alleged and painted as tax avoidance. The device used to construct this artificial judgment, though, was an assertion that Apple had received financial assistance in the form of low rates of taxation from Ireland and that this ‘state aid’ was forbidden under EU ‘rules’. This interpretation of accepted international tax law is interesting to say the least.
Quaintly, government support given to banks throughout Europe (and particularly in the UK) to ensure their very survival during the global financial crisis was not deemed to have been ‘state aid’.
Within days of that ‘judgment’ the USA declared that negotiations on a trade deal with the EU were over.
This was followed rather swiftly by the US Department of Justice imposing a $14 billion fine on Deutsche Bank on the grounds of mis-selling (packaging and selling toxic debt monetized in the guise of AAA grade assets). As you will have seen in recent news bulletins, Deutsche Bank is in grave financial difficulties and close to failure and its share price has plummeted accordingly. How enigmatic that the amount of each of these fines is strangely similar.
It is also interesting to note that the US has chosen its target well. Deutsche Bank is close to collapse; will the Germans allow it to go bust or will they step in with financial support (although they were not prepared to help Italian banks in this way)? Would that be “illegal state aid”? If a German bank, of all things, were to go bust what would that say about that famed German financial rigour (as used to impose discipline on Greek and Italian banks!) and what would it do for the future of the euro itself. Hats off to the US official who thought out that particular tactic!
In the background to all that, for the past 5 years the EU has being doing its best to find an excuse to fine Google over claims that it has become too dominant in its field of business which. of course, is deemed to be ‘unfair’ in the other-worldly eyes of the EU. Apparently, being too good at what you do (and therefore beating the competition hands down) falls foul of EU anti-competition rules. To inflame matters further, a US investigation in 2013 cleared Google of misusing its dominant position (well they would, wouldn’t they) in the way that the EU were representing.
All good clean fun. In its move against Apple I can only conclude that the EU was trying to get its retaliation in first! The idea that the EU could overturn or even challenge the USA’s global financial hegemony is an alarm call for the men in white coats to pay an urgent visit to Brussels.
It all goes to show that the pantomime season has started early this year!
EU Rules and Reality
The EU’s unbendable and unbreakable ‘rules’ (and how they are ignored when expediency suits our bureaucratic dictators).
The truth is that these ‘rules’ are simply words that sound good and are meant to intimidate. However, they are subject to whatever political interpretation suits the Brussels mafia at any given point in time.
For example, the ‘sacred’ stability and growth pact which, when the euro was first introduced, was meant to limit each EU country’s budget deficit to 2 percent. As soon as the real world interfered with the EU’s Malice in Blunderland economic illiteracy, this pact became unworkable and was quickly and quietly removed.
Likewise, the ‘no bail-out’ clause intended to protect members from bankrolling other nations was quietly torn up as soon as the Euro started to collapse. It could well become the same with the ‘single market’ and ‘open borders’.
Quite simply, the modus operandi of the EU is that all their apparently implacable ‘rules’ are broken with impunity if political expediency requires them to be broken in order to maintain the charade.
The next potentially market-moving event is the US Presidential election which is now only a month away. Both candidates are equally unpalatable and are neck-and-neck in the opinion polls (which, of course, have proved to be so reliable in recent elections and referendums!).
I have no doubt that stockmarkets will react negatively whichever of Clinton or Trump prevails but I believe this will be just a short term effect. We have known for three months or so that the choice falls between just these two unimpressive candidates and so the final outcome will not be a long-term surprise to financial markets.
If Clinton wins she will in effect be a non-executive figurehead only and have no real legislative power. The US legislature (Congress, comprising The Senate and the House of Representatives) is firmly dominated by the Republican Party which will subdue and overwhelm any of Clinton’s wilder inclinations and expenditure. She is profoundly disliked and distrusted by over 60% of Americans most of whom would dearly like a change away from the socialist policies pursued by the Obama administration over his two terms in office and which are so foreign to American culture. In many parts of the United States it is now possible to ‘earn’ more on welfare than it is to work which is a shocking betrayal of the aspirations inherent in the ‘American dream’. The fact that Clinton is still in the race is a telling commentary on the persona of her Republican rival.
Trump is beyond parody. Is he as crass as he appears or is he dumbing down and making wild and idiotic statements in order to appeal to red-necked Americans, the very people who would normally vote for the Democratic party? Time will reveal all. If he should prevail and be sworn in as President then Congress will no doubt also supress Trump’s idiotic and exuberant buffoonery.
It beggars belief that, on the face of it, these two are apparently the best alternatives America has to offer.
Once the election outcome is known and when the dust has settled, I am sure markets will quickly refocus on economic rather than political news.
This month has been relatively subdued, reflecting lower then normal trading volumes during the main summer holiday season. There have, however, been some points worth noting for their potential to move equity markets.
The first of these is the timing of a long-expected upward movement in US interest rates. Yet again market commentators in America are pushing the case that this change will be made at the September meeting of the Federal Reserve. We remain of the view that nothing will be done in advance of the US Presidential election and so December remains the most likely time for this well touted increase. Whatever the reality, an increase of 0.25% should not be much of a shock and is unlikely to have too dire an effect on equity valuations.
Of more immediate effect has been another politically motivated intrusion by the unlovely Hillary Clinton who, in the last week of August and entirely for electoral reasons, repeated her empty threat to control price increases by drug and biotech companies. The paucity of her assertion is obvious but it again had the short-term effect of an across-the-board markdown of 3% in the biotech and pharmaceutical sector. Economic reality will reassert itself shortly.
After ten years of strategic talks and three years of serious and detailed negotiations it was quietly announced by the German vice-chancellor over the last weekend of August that the mooted EU/US trade deal has finally collapsed. Perpetual disagreements between the two sides have killed off any prospect of a deal to establish the so-called Transatlantic Trade and Investment Partnership (TTIP) and so commercial traffic between these two blocs will continue under the aegis of World Trade Organisation rules (as has been the case for many years now).
Britain had been a major supporter of TTIP but with its impending departure and the ongoing impossibility of getting 27 disparate countries to agree on acceptable trading terms the talks have come to an impasse. France objected to opening up Europe’s farming and film industry to competition from the US whilst Germany opposed any potential undermining of labour and environmental standards. Similar EU negotiations with India and China over the past ten years have also ended in terminal deadlock. Sadly, the unilateral self-interest, protectionism and discrimination on which the EU is founded will continue to prevent its development as a credible economic unit.
It may be coincidental but the EU’s misguided attempt to impose a demand on Apple for ‘unpaid taxes’ may have been the straw which has finally broken America’s patience with what the US Treasury describe as the EU’s attempt to become a ‘supra-national tax authority’. It is quite clear that the EU has acted well beyond its powers in arriving at this invented ‘judgement’ and both Apple and the Irish Government will appeal the ‘ruling’. The EU’s logic and its controversial interpretation of international tax law is laughable in its idiocy and will only lead to years and years of unresolved legal argument.
On 31st August the FTSE 100 closed at 6781.51(a rise of+0.85%for the month of July and +8.64%forthe 2016 year to date). The mid-cap and small-cap indexes have not done as well thus far this year; however, the slow ones now will later be fast. By comparison, the Quotidian Fund’s valuation at the same date shows an uplift for the month of August of +0.91%and for the year to date the Fund is now – 8.89%. We continue to claw back the ground temporarily ceded during two substantial global market downturns earlier in the year and, with four months of the year remaining, I remain confident that we will be nicely into profit for 2016 by the year end.
Theodore Roosevelt once described America’s foreign and economic policy as “Speak softly and carry a big stick”. It obviously worked as the US has since established global financial hegemony.
The EU clearly prefers to use “Speak very loudly and carry a plasticine baguette” as their mantra. It doesn’t carry quite the same force and, fundamentally, it doesn’t work. Empty vessels.
The EU thus continues to prove itself to be a clueless, inefficient and fraudulent bureaucracy which works entirely and tirelessly for the benefit of its political elite who, in turn, have an infinite capacity to recite (or create) unenforceable rules. Strangely, those same rules are circumvented or ignored completely when political expediency and self-interest demands.
Wittingly or unwittingly it repeatedly continues to expose the central and fatal flaw in the entire charade. Its unelected technocrats like to act as if the EU has sovereign power over its individual member countries but, of course, this is far from the reality. In its unseemly rush in the early 1990’s to establish the Euro as its common currency its leaders failed completely to establish the necessary political and fiscal union as an essential prerequisite. The EU is thus holed beneath the waterline.
Much as they would like to believe it and much as they like to bluff, the EU has absolutely no legal right to interfere with a sovereign country like Ireland’s taxation policies and political choices. Hubris is inevitably followed by nemesis and persistent illegitimate acts of overbearing arrogance by its elite will ultimately (and thankfully) bring about the demise of the entire EU federalisation project.
On a positive note, the collapse of TTIP will have a beneficial implication for Britain in that, following Brexit, the UK will be free to negotiate a mutually beneficial trade agreement with the USA without any of the baggage that the EU brings with it. Such a deal will not take long to ratify.
A month on from the Brexit vote and there is growing evidence that the pre-referendum warnings of catastrophic consequences in the event of a decision to leave the EU were, to say the least, overdone. Deception masquerading as ‘facts’ was the hallmark of the ‘remain’ campaign as can now be clearly seen.
There are welcoming signs of future trade agreements with, among others, China, India, the USA and Australia and the predicted stampede of companies leaving the UK has not materialised.
In the immediate future, though, the first bridge to cross has to be an equitable exit from the EU.
As we will all be aware, the first step in that process is to invoke Article 50 of the Treaty of Lisbon and the UK controls the timing of that in entirety. Whilst the EU might wish to rush things (in order, of course, to avoid any contagion of Brexit to other countries) it is entirely in the UK’s gift as to when that button should be pressed.
We are already in the EEA (European Economic Area) which is where (once outside the EU) we must choose to remain. This, together with an application to join the European Free Trade Area (EFTA) will give the UK an immediate solution to the ‘access to the single market’ trading problem.
More importantly, under Article 112 of the EEA Agreement, the UK also has the unilateral right to claim a partial opt-out from the EU’s ‘freedom of movement’ rules. This would allow us to set up a quota system to control immigration from other EU countries.
The EU will no doubt seek to encourage us into going along with their much-touted plans for a ‘two-tier’ Europe which would leave the present Eurozone countries united and centralized and with the UK and other non-euro nations sitting on the side-lines (where we would possibly be joined by so-called ‘neighbouring’ countries such as Turkey and Morocco).
This will no doubt be portrayed by the EU as a very attractive compromise whereas it would, in fact, be a highly deceptive and damaging strategy for the UK. It would still leave us as a part of the ‘supranational’ EU system but as a second-class member and still with all the disadvantages that we voted to extract ourselves from.
EU rules dictate that negotiations for exit must be completed within two years of triggering Article 50. The most disastrous option is that we could reach the end of our two-year negotiation period without any agreement having been reached. Bearing in mind that the EU has already taken 10 years to negotiate a trade deal with the USA and still there is no agreement in sight. Likewise, negotiations with India were abandoned after nine years of pointless wrangling and the inability by the EU end of things to make a decision. The impossibility of 28 countries reaching accord is palpably obvious when one looks at the pigs-breakfast they have made of trade negotiations thus far.
On invoking Article 50, therefore, the UK should immediately apply for an extension to the 2 year negotiating period (as the rules quite legitimately allow us to do) in order to avoid the absurd situation where, after leaving the EU but in the event of having failed to reach an acceptable exit agreement within 2 years, the remaining EU counties could still sell to us but we would no longer have the necessary paperwork to sell to them!
We must hope that our negotiators are capable and well-informed enough to negotiate the labyrinth and the sophistry of their EU counterparts.
On 31st July the FTSE 100 closed at 6724.43 (a rise of +3.38% for the month of July and +7.72% for the 2016 year to date). The main UK index has already surpassed its pre-Brexit level. By comparison, the Quotidian Fund’s valuation at the same date shows an uplift for the month of July of +15.39%and for the year to date the Fund is now – 9.71%.
As was predicted in last month’s report, the immediate post-Brexit equity market markdown was synthetic, transient and based purely on panic and fantasy. Nothing could better illustrate the artificiality (one could even say cynical) nature of that negative adjustment to equity prices than the speed of our recovery. Substantial ground was regained by the Fund over the month and we remain confident of continuing positive momentum into profit before the year-end. That sanguine assertion is supported by the following technical analysis:
For the past twelve months equity markets have been stuck in a frustrating trading range which has continued to test the patience of investment managers and investors alike with not just one but three sharp stock market downturns of 12% or more over that period. Frustrating though they are, it is these downturns that eventually pave the way for the next bull run higher.
Taking the S&P 500 index as an example, history shows that whenever stocks take “a long pause” between 52-week highs and then finally manage to break out to the upside, they go on to post even further gains over the following 12 months (according to research from Merrill Lynch for which I am obliged). The Merrill Lynch data shows that whenever stocks have gone for more than 300 calendar days before making a new 52-week high then, 91% of the time, the S&P 500 continues to go up over the next 12 month period. That is rather an encouraging precedent.
The S&P 500 Index last attained a new 52-week high in May 2015 but in recent weeks it began to close in on that highpoint once again and then actually reached a new all-time high at a level of 2175 on 22ndJuly. Such a bullish signal has only occurred 23 times since 1929, and in the succeeding 12 months it has produced above-average gains for equities 9 out of 10 times in the past.
Rather than yet another correction downwards as so many relentlessly negative ‘experts’ are keen to predict, the historical analysis above suggests that this index will rally further to even higher highs over the coming year. And where the US market leads, global markets follow.
We ended last month’s report by highlighting that the two most obvious stock-market sensitive issues in June would be the Federal Reserve decision on US interest rates at its mid-month meeting and the outcome of the UK referendum on EU membership. Of course, we now know the actuality in both cases.
Predictably and as entirely expected the Federal Reserve decided to leave US interest rates unchanged at their mid-month meeting. At the press conference following that meeting Janet Yellen used 13 variations of the word “uncertainty” in her summary of the Fed’s views. Hardly confidence inspiring stuff. We remain of the view that US interest rates will stay on hold until December at the earliest.
Elsewhere, interest rates are now at zero or in negative territory. For example:
- The interest rate in Switzerland is at minus 0.75%
- In Sweden at minus 0.50%
- In the Eurozone at minus 0.40%
- In Japan at minus 0.10%
- In Great Britain at +0.50%
- In conjunction with this, global bond markets also continue to go from bad to worse.
Switzerland’s central bank announced that it will be selling a 13-year bond with a yield of zero. If you now want to earn a positive yield on Swiss debt you have to go out to a term of 20 years.
The finance arm of Toyota Motors has just offered a three-year unsecured loan note with a yield of 0.001%. To put that into better context, if that was your yield on a savings account it would take 69,300 years to double your initial investment.
Germany’s Bundesbank has just published a measure of the average yield on that country’s government debt which showed that the average had just dropped below 0% for the first time ever.
In fact, early in June the yield specifically on the benchmark German 10 year bond sank to within two basis points (two-hundredths of one percentage point) of zero. Then, on 14thJune and for the first time in its history, the yield on that 10-year bond went below 0% and later fell as low as minus 0.035%.
Early June the yield on the Japanese 10 year note fell to a record-low negative of minus 0.15%.
This has coincided with a massive worldwide push toward lower and lower yields with Japanese 10 year bond now declining even further to minus 0.19%, Swiss 10’s falling to minus 0.55% and British 10’s dropping to an all-time low of 1.11%.
Meanwhile average incomes have been stagnant for nearly a decade. Given this scenario and the alternatives on offer, for an investor who wishes to make a positive return and hope to keep pace with inflation it does rather make an unequivocal case for equities as being the only potentially beneficial and liquid asset class in today’s investment environment.
The relentless doomsday narrative of David Cameron, the Bank of England and their erstwhile fellow-travelers around the world had the effect of setting the scene for a self-fulfilling financial panic following the UK referendum result in favour of leaving the EU.
Their claims were based on dubious analysis and were deeply irresponsible. Markets panicked entirely as a result of the hysteria that this scaremongering had quite deliberately generated. Policymakers around the world were then duty-bound to dampen financial turbulence and, indeed, within a week the main UK index has regained its pre-referendum levels. It may take slightly longer for the mid-cap and small-cap sectors to make a similar recovery but, essentially, the current downturn in valuations will be transitory.
A study from the International Monetary Fund (IMF Country Report No.16/169 dated 1stJune) which, quaintly, was released at the same time that Madame Lagarde (the IMF Chief Executive) was issuing her dire warnings about the extreme dangers of Brexit, clearly shows that the share of British goods exported to the European Union had fallen to 45 percent in 2014 from the 60 percent it had been in the year 2000. More recently it has fallen even further to 42%. This ongoing shift away from slow-growing Europe and towards the rest of the world was always set to continue irrespective of Brexit.
Modern economics is based on calculus; the field of mathematics developed by Isaac Newton (and some say Gottfried Wilhelm Leibniz) in the 17th century.
It is still that branch of maths which underpins many economic forecasting models. Indeed, the same model that earned Professor Lawrence Klein the 1980 Nobel Prize in Economics is essentially the one that Federal Reserve still uses today and it is also the forecasting approach relied upon by many establishment economists all over the world.
And it’s all still based on 17th century calculus, which is very good at calculating rates of change but very inadequate for predicting changes in direction; and it is absolutely dreadful when it comes to anticipating sudden breaks with the past. That’s why most economists in the public sector are as clueless today as they were in failing to foresee the financial crisis of 2007 onwards and predict the detrimental effects of the Euro on the economies of so many countries in the Eurozone. The woefully inaccurate forecasts produced in the lead-up to the UK referendum provide further evidence of the dangers of complacent, unquestioning group-think.
The entire official campaign in favour of remaining in the EU was based on claims that British productivity would fall precipitously. There is absolutely no evidence to support this assertion. At the very least, the long-term economic consequences of Britain leaving the EU are neutral to positive.
Upon leaving the European Union Britain will possibly trade even less with Europe but much more with other nations around the world. The current decline in value of the British pound against the US dollar will, of course, be of great benefit to the competitiveness of British goods in export markets but, whilst it is entirely possible that overall trade may fall somewhat during this potential transition, there is a consensus among business-focused economists that the costs of such a decline would be small and short-lived.
On 30th June the FTSE 100 closed at 6504.33(a rise of+4.19%for the 2016 year to date). By comparison the Quotidian Fund’s valuation at the same date shows a fall for the month of June of –12.89%(all of which came as a result of the post-Brexit panic) and for the year to date is now – 21.37%.
As you already know, in the two days following the Brexit vote the wheels came off the UK stock market. The FTSE100 fell by roughly 8% and the wider market by much more. The FTSE 250 was marked down by over 14% in just those two days.
Contagion spread to global markets far and wide. The Dow Jones Industrial Average plunged 871 points in those same two days, whilst the S&P 500 sank to a three-and-a-half-month low. The Nasdaq Composite also tumbled more than 315 points post-Brexit and there was absolute carnage in certain sectors of the markets.
Pharmaceuticals have always been widely seen as a defensive sector but, perversely, it was one of the worst hit in this short-term valuation mark-down. However, there is already growing confidence in the City that this initial pessimism was overdone and that the implications of Brexit may not be as far-reaching as the doom-mongers had suggested. I have no doubt that share prices will continue to be marked up again to pre-referendum levels in the oversold sectors of the market.
In the short term we find ourselves back at our end-of-February levels of valuation. I can do no better than repeat the essence of what I said at that time:
Market turmoil following the UK vote to leave the European Union is well beyond irrational and better described as insane, but it istransient. Share prices have always recovered after mark-downs in the past and they will recover this time too; it is only a function of time before our holdings return to more realistic valuations.
We remain entirely comfortable with our current portfolio holdings; we have held firm and haven’t been panicked into selling any assets as this downturn has persisted. We haven’t, therefore, crystallised a paper markdown into an actual loss.
Immediately before the referendum took place we were very near to positive territory for the year to date. By mid-June we had recovered almost completely from the early year pricing mark-downs and I have no doubt that we will soon recover the ground lost in this post-Brexit panic too.
The major market indexes ended the month of November at much the same level as they had started it. For those who take just a passing interest and only occasionally look at the progress of stock-markets it might well have appeared to have been a benign month. Nothing could have been further from the truth.
In fact, those who monitor markets closely on a daily basis will have seen a much different picture. In the second week of the month we witnessed a recurrence of the brutal and dismal market conditions of August and September.
The proximate cause of this return to bedlam was the issuance of US employment numbers and associated data on 6th November. These figures showed a far, far more positive position than had been generally expected with unemployment falling to just 5% and coupled with improved levels of income.
Whilst all this was clearly good news, it raised market expectations of the long-heralded US interest rate rise now actually being implemented at the Federal Reserve meeting in December. In reality that should not be a problem but market-makers still seem to feel obliged to perform an initial knee-jerk negative reaction when interest rates rise.
As ever, the Federal Reserve will make its statement at the end of their next quarterly meeting on 17th December; just in time for the possibility of a traditional ‘Santa rally’. It is worth noting that in 25 of the last 31 years the equity markets have rallied in December and so it would not be a complete surprise if this were the case again. However, lingering doubts related to US interest rates and potential further terrorist activities may act as a dampener this year.
In fact, towards the end of November market attention became centered on the appalling terrorist outrages in Paris. In the past, equity markets have rapidly headed southwards in response to such reprehensible acts and market participants were braced for a major sell-off on the Monday following that previous Friday evening’s events.
From the forensic investigation that followed the 9/11 attack on the World Trade Centre in New York we became clearly aware that the terrorists had shorted the US stock-market in advance of their violent strike. The very substantial profits they thus made have since been used to finance further atrocities.
One of the few pieces of positive news to emerge from their latest acts of barbarism in Paris was that global markets did not sell-off sharply but responded in a calm and measured way and maintained their composure. As a result, an equity market rally this time caused the terrorist short-sellers to sustain substantial financial losses (which is both morally satisfying and about as much as capital markets are able to inflict in terms of retribution).
On 30th November the FTSE 100 closed at 6356 (which denotes a fall of -3.20% for 2015 to date). It also represents a fall of 0.08% during the month of November.
By comparison the Quotidian Fund at the end of November stood at +17.99% for the year to date, having been marked down in value by +0.76% in the month. We currently stand 21.19% ahead of our benchmark (being the FTSE100 index).
Markets all now await the Federal Reserve’s rate decision on 17th December. Currently there is a 70% chance of an increase in US rates at that meeting (which would be the first increase since 2006) but that upward move is only expected to be at the very modest level of 0.25%. Signals from Janet Yellen (the Fed’s chairman) suggest that this will be followed by similarly minor increases over the next twelve to eighteen months entirely in harmony with economic progress in the USA. Present indications are that there is a ceiling of 2% in mind as the maximum target rate. We do not expect that to create a long term problem.
It is salutary to note that the major market indexes (and particularly those in the USA and the UK) now stand at roughly the same level as they did in November 2014. In light of that, Quotidian’s comparative performance illustrates the added value of active professional investment management as opposed to simply opting for market tracker funds or the ‘structured products’ on offer from the usual suspects. We have frequently described tracker funds as too often providing ‘return free risk’ and that assertion is clearly evidenced by this latest example.
As ever, though, we recognise that unmonitored stock-markets can rather sharply make one look very silly indeed and so will keep the sound of trumpets muted and focus on trying to maintain our positive progress through these uncertain times.
The long anticipated decision to increase interest rates in the USA for the first time since 2006 was finally confirmed by the Federal Reserve in their December mid-month meeting. As expected, the increase was at a rate of just 0.25%.
In her summary following the rate announcement Janet Yellen emphasized that negative economic forces were being offset by solid expansion of domestic spending and added that foreign economic risks “appear to have lessened since the summer.” She described the dollar’s rise as “transitory” and made a point of stating that any future interest rate rises would be of a similar minimal size and would only be implemented in harmony with US economic growth.
Despite her dovish commentary the immediate aftermath of every Fed meeting is always volatile in equity markets with whiplash moves in both directions. The real underlying trend typically asserts itself once the short-term turmoil ebbs away.
Indeed, equity markets, in typical fashion, immediately reacted violently; in the following two hours stocks initially sank, then they soared, then they sank again, and eventually the Dow surged 224 points upwards by closing bell. The dollar remained roughly flat.
2015 will go down as another year of above average volatility. Following steady and generally upward momentum in the first half of the year equity markets did then have their periods of bedlam from August onwards. In August itself we saw the 2015 version of a “flash crash” when the Volatility Index (VIX) spiked from below 11 to above 50 in just three weeks.
Take your pick as to the culprit/s for the dramatic August sell-off that saw the Dow shed 2,400 points in just those three weeks (and I’m probably omitting a few worries from this list):
- China’s seeming economic slowdown – although China’s GDP growth still shows a clean pair of heels to much of the rest of the world
- European debt and immigration concerns – indeed the very existence of the EU in it present form remains questionable
- Deep falls in Commodity prices in general and the price of oil in particular
- Corporate profits under pressure
- Fears that the Federal Reserve would increase interest rates in the USA, and, perversely
- Fears that the Federal Reserve would not increase interest rates in the USA!
August and September saw a convergence of most of the items on the ‘worry list’ and although stock market volatility subsided briefly in October it returned with a vengeance in November and December.
In December, which is traditionally a bullish month for stocks and shares, extreme volatility kicked off once again.
First, the People’s Bank of China (PBOC) followed up on its big “one-off” yuan devaluation in August with yet another effective devaluation of similar magnitude. For as long as the dollar remains strong the PBOC may feel the need to adjust the yuan lower in response (thus potentially injecting more turbulence into equity markets as was the case in August).
In addition, the European Central Bank (ECB), the Bank of Japan (BOJ), the Bank of England (BOE) and many other global central banks are walking a similar tightrope too; trying to “devalue” their own currencies by using various forms of monetary stimulus. The trick is to do so without going as far as to trigger a crisis of confidence with resultant capital flight out of their own economies. It’s a risky business.
On 31st December the FTSE 100 closed at 6242 (which represents a fall of -4.93% for the 2015 year). It also confirms a decline of 1.79% during the month of December.
By comparison the Quotidian Fund at the end of December stood at +16.56% for the year, having been marked down in value by -1.22% in December itself. At year end we stand 21.49% ahead of our benchmark (it being the FTSE100 index). It is worth noting that this December mark down occurred on the very last two trading days of the year (when trading volumes were thin to non-existent). This is a perfect example of artificial pricing but, of course, we are obliged to “mark to market”. No doubt the real trend will emerge as 2016 gets into its stride.
You will have seen in our November monthly report that we anticipated the short-term market reaction to the very likely event of a December rise in US interest rates. Given that this increase had been widely signaled by the Federal Reserve for the past nine months or so it was hardly Einsteinian insight on our part.
We highlighted “market expectations of the long-heralded US interest rate rise now actually being implemented at the Federal Reserve meeting in December. In reality that should not be a problem but market-makers still seem to feel obliged to perform an initial knee-jerk negative reaction when interest rates rise”.
We went on to say that “We do not expect that to create a long term problem”.
Indeed, the actuality closely followed that script. On the day of the interest rate announcement markets gyrated frantically before closing on the high side. The following two days were profoundly negative but the panic subsided again just another two trading days later.
Volatility is established as a feature of stock markets nowadays and likely to remain a permanent element. That being so, our role encompasses managing that volatility as best we can. We are pragmatic and do our utmost to extract emotion from the decision-making process. Stock selection is the key to consistently above average performance; aiming to be in the right stocks in the right sectors of the right markets at any given point in time is our guiding strategy. That philosophy served our investors well in 2015 (and indeed for years gone by).
Fundamentally, if we believe that market negativity is a true reflection of real economic problems then we would seek to liquidate or reduce our exposure. In many cases, though, equities are simply being subjected to synthetic price reductions (by market makers seeking, inter alia, to test the resolve of certain types of investor). If we deem this to be the case then we seek to take advantage of short-term opportunities and top up reliable holdings at ‘bargain’ prices.
Many of the worries on the list above will no doubt continue to dog equity markets in 2016. Despite that, however, we remain sanguine to the achievement of positive performance in 2016 via meticulously selected stocks in carefully chosen sectors of the equity markets of very specific countries. We continue to have confidence in the individual stocks and assets that currently comprise the Fund’s purposefully focused and concentrated portfolio.
The first two weeks of February saw an even further worsening of the decline in equity valuations that has bedevilled global stock-markets since the first trading day of the New Year. Fear-motivated panic, stoked by those who have a vested interest in creating volatility, reached a crescendo by the end of the second week of this month at which point the FTSE100 index sank to a reading of 5499.
As the usual Cassandras who issue them know full well, the trouble with doom-laden statements is that they have a nasty habit of becoming self-fulfilling. It is food for thought that in the spring of last year Footsie had risen to its apogee of just over 7200; February’s low-point represented a fall of 25% on the main UK market index from its all-time peak last April.
Despite the continuing negativity and volatility in financial markets profitable business is still alive and well in many parts of the world. There is no rhyme or reason behind the extreme gyrations that still prevail across the board in equity valuations.
- I particularly want to expand on the views expressed in my January report as to the market’s direction and the reasons behind it……..and to reassert that I do believe these bear market conditions are, to a large degree, synthetic and will have reversed by the end of May.
- For the time being, though, you will have seen that the madness still persists and the reason I describe this markdown as artificial is drawn, inter alia, from the market’s reaction to the fourth quarter results now being issued in the US and the UK (our two main areas of investment). Of our individual company holdings, thus far in this results season 11 of them have now reported.
- Of those, 3 (Manhattan, Gilead and Biogen) have produced brilliant figures, well ahead of market expectations. Another 6 (Electronic Arts, BioMarin, Celgene, Apple, Alexion and Starbucks) have produced figures that equal or beat expectations by a little way…….and only 2 (Amazon and Regeneron) have produced disappointing numbers.
- Despite that, all of these shares have been savaged in the current market negativity. The point is that demonstrably these are real companies making tremendous real profits in the real world……yet the market is determined to mark everything down on the back (apparently) of falling oil prices!
- As I say, it is transient and actually presents a great investment opportunity for investors to increase their exposure to carefully selected equities at a very low ebb in global markets. It may continue to get worse before it gets better but I still see May as being the most likely time of a return to more positive conditions.
- The Healthcare (Pharmaceuticals & Biotech) sector has been particularly badly marked down although actual corporate performance has continued to be robust. At some point in the relatively near future that reality will return to valuations.
The economic situation in the USA is a template for the global economy.
In February, Janet Yellen (Chairman of the Federal Reserve) appeared before the US congress to testify on the state of the US economy, its monetary policy and associated financial issues germane to the equity markets. To summarise her major points:
- The US employment market continues to strengthen. Labour market data shows persistent jobs and wages growth and growing confidence. In her testimony on 10th February Yellen cited the 2.7 million increase in payrolls last year and the 13 million in cumulative jobs added since 2010. She also emphasised that unemployment was now running at a rate of only 4.9% and that there were “noticeable declines” in underemployed and ‘discouraged’ workers.
- Economic growth is good but not yet great — Yellen noted “moderate expansion” in GDP, emphasising household spending in general and housing and auto sector growth in particular. But she also acknowledged that “subdued foreign growth and the appreciation of the dollar” were holding things back and she noted weak activity in the energy sector.
- The Fed chairman highlighted declining stock prices, rising borrowing costs and a rising US dollar saying that they “could weigh on the outlook for economic activity.” She also made reference to the risks associated with China’s economic slowdown and weaknesses in commodity-linked economies.
- At the same time, though, she blunted those concerns by saying that “ongoing employment gains and faster wage growth” should help the US economy. She also said that “highly accommodative monetary policies abroad” would be likely to boost global economic growth. In other words she basically said the Federal Reserve would not be by forced by plunging equity markets into a change of course to cutting US interest rates nor launching another round of Quantitative Easing.
After the truly dreadful second week of February, equity markets have since reacted positively to Yellen’s testimony.
Elsewhere in the world:
- China’s economy is struggling through a transition from being an export-led manufacturing-intensive economy to being more reliant on domestic consumption.
By some measures China is already succeeding on the economic front, in spite of its fractured stock market.
True, China’s industrial sector is going from bad to worse with the Manufacturing PMI contracting steadily. But at the same time, China’s service sector (including financial services, retail, travel and leisure, health care and education) is thriving; more than making up for the slowdown in factory output.
The reality of that is supported in these figures:
- China’s retail sales hit a record high of $4.2 trillion in 2015, and sales are expected to top $6.5 trillion within the next 5 years; a 50% growth rate.
- Domestic passenger rail traffic is up 10% over the past year, and Internet traffic more than doubled last year alone.
- Last year, and for the first time, China’s middle class (at 109 million consumers) exceeded America’s middle class (at 92 million).
And that is the reason why the service sector of China’s economy is growing so rapidly; a thriving and upwardly mobile middle class. An annual GDP growth rate of 6% plus is far from shabby. The USA and Europe can only wish that they should have such growth “problems”.
At the moment that is not reflected by their stock market. However, China’s stock-market tends to be a trailing indicator of the economic situation whereas in the West we are more used to stock-markets being leading indicators of economic development. Time alone will bring the Chinese market into line with what we clearly identify above as positive trends for their economy.
- Cyclical problems will fade; structural ones will not. The elephant in the room in respect of equity valuations remains that of huge and ever-increasing sovereign debt in so many countries around the world. Strangely, national politicians and world leaders seem somewhat reluctant to draw attention to their own profligacy and apparent inability (or unwillingness) to reign back government spending and reduce sovereign indebtedness.
- The attraction of German equities and why:
Germany’s debts are equivalent to just 71% of their GDP which is much more manageable than that of most countries. In comparison, the UK’s indebtedness now stands at 87% of GDP and the average for the Eurozone is 93%. There are many examples of countries where debt is well over 100% of GDP.
Household debt in Germany stands at 83% of GDP whereas in the UK the equivalent figure is 125%. Thus the German consumer has more discretionary income to spend and, in so doing, will boost the local economy.
Germany has a particularly low birth rate and a shrinking population. This might explain their enthusiasm to take in a substantial number of refugees from the Middle East and Africa. In the long term that will most likely be of great benefit to their economy.
The Eurozone’s monetary policy has to cater for the less well managed economies of southern Europe (Greece, Italy, Spain, Portugal and others) and as a result is currently too loose and likely to remain so. This will benefit the value of assets in Germany (shares and property).
- The USA’s Nasdaq market has been hammered in the first two months of 2016.
After being the best performing global market for the past three years it has been virtually unwatchable this year and currently stands down -17.50% from its December 2015 high.
We don’t think that that blood-letting has been a fair reflection of economic reality. After years of relatively smooth upward momentum the Nasdaq was due for a typical correction but the speed and depth of its recent downturn defies common-sense.
However, we note and are reassured by the fact that when this kind of severe pullback has occurred in the past there has usually been a pause for breath over the following few weeks before the long-term uptrend has resumed. We anticipate the same response to this recent short-term downward pressure.
On 29th February the FTSE 100 closed at 6097 (a fall of -2.33% for the 2016 year thus far); little changed from the end of January although having suffered significant falls mid-month.
By comparison the Quotidian Fund’s valuation at the end of February is down by – 21.32% for the year to date; only a slight decline since January in spite of the mid-month market collapse.
Falling oil prices and a supposed slowdown in China are simply diversions intended to take attention away from the fundamental truth of sovereign financial mismanagement.
Supporting evidence for this assertion comes in the performance of the Chinese stock-market and its supposed effect on global markets. We were asked to believe that the decline of 7% in China’s equity market on the first trading day of this year was the proximate cause of the huge and sustained falls in global equity markets that then followed. It is interesting to note that on 25th February the Chinese stock-market again fell by 7%; however, the reaction this time was that equity markets around the world rose by 2% or more! So much for the New Year fairy story.
Politicians worldwide have proved adept at kicking the sovereign debt problem into the long grass or introducing measures to postpone the necessary action and simply knocking it further down the road. However, as I asserted in January’s report, until governments find the political will to control their spending and begin the process of reducing their national debts then we will continue to experience short term periods of volatility in financial markets. Far be it from me to sound cynical but one sometimes wonders if many our global political leaders actually do know their ACAS from their NALGO.
Our relatively recent experience of Gordon Brown’s inept mismanagement of the UK’s Treasury provides vivid proof that the socialist ideology of spending one’s way out of debt has been entirely discredited. The UK is still dealing with the financial consequences of his many failings.
Sadly, Europe is still dominated by similar left-wing ‘thinking’ and the less said about the USA under Obama’s insipid and financially incontinent stewardship the better.
Quotidian’s portfolio is focused on quality assets and we remain entirely confident with our current holdings; we also remain resolute and have not been panicked into selling any assets as this downturn has persisted. Thus we have not crystalised a paper markdown into an actual loss.
Historically, big stock-market falls have been the trigger for a big rebound. When the current bedlam subsides we are confident that our asset holdings will return to realistic valuations.
The main market-moving issue of any real note in March related to the European Central Bank President Mario Draghi who, together with his fellow EU policymakers, convened in Frankfurt on 9th March with a view to creating yet another “whatever it takes” plan in an effort to bolster the Eurozone’s financial strength.
Blissfully ignoring the fact that none of their previous programs had met their intended objectives (in particular, for three years now annual inflation in the Eurozone still lags the ECB’s 2% target rate) Draghi seemed determined to give markets everything they wanted at this latest policy meeting. The result was that they:
- Cut the ECB’s refinancing rate to 0% from 0.05%
- Cut the EU’s deposit rate to –4% from –0.3%
- Expanded the EU’s Quantitative Easing program (QE) to 80 billion euros per month from 60 billion…a figure that trips easily off the tongue but takes on a more shockingly profound focus when you write it down and consider the number of zeros involved
- Added euro-denominated investment-grade corporate bonds to the list of ‘assets’ the ECB can buy with its QE freshly printed money
- Extended the projected end date of QE to at least March 2017 from September 2016…with the implication that it will be further extended beyond that in due course
- Launched four new “Targeted Longer Term Refinancing Operations” (targeted loan programs designed to encourage banks to lend to the real economy).
It does seem rather quaint that the ECB feels the need to incentivise banks to actually perform the very function they are in business to do. Somewhere along the line banks seem to have forgotten that the fundamental cornerstone of their business is lending; it appears that they much prefer to pursue a range of non-banking related avenues as a means of increasing their revenue and profits (although they don’t seem to be much good at those either unless they’ve rigged the relevant markets).
In short, Draghi tried to do everything he could to signal that monetary policy still has potency but he now runs the risk of exposure to the law of diminishing returns. As has been clearly evidenced from rounds of QE in other parts of the world, despite those massive infusions of easy newly-printed money policymakers around the globe are still missing their own inflation targets.
That’s not just my view, by the way: it is also the assessment that the International Monetary Fund and the Organization for Economic Co-operation and Development have both concluded.
None of the ECB’s actions actually solve the fundamental flaws in the single currency of the Eurozone. They treat some of the symptoms for the short-term but do not cure the disease.
In the USA, the Federal Reserve held their latest meeting on 16th March and as entirely expected they decided to leave US interest rates unchanged.
Specifically, the post-meeting statement said that “household spending has been increasing at a moderate rate,” that the “housing sector has improved further” and that there has been “additional strengthening of the labour market.” It also said that prices might be low now, but they should rise “as the transitory effects of declines in energy and import prices dissipate and the labour market strengthens further.”
Consequently, the Federal Reserve lowered their projection on the number of rate increases they are planning to implement this year. The expectation now is for just two very modest rises compared with four previously.
Despite that clear message the markets reacted badly and in knee-jerk fashion to just one US analyst’s contradictory report implying that he expected an additional rate increase to be applied in April. That caused another bout of wild short-term swings in the US markets which then infected global markets.
As the resulting uncertainty continued to reverberate around stock-markets worldwide, Janet Yellen felt obliged to firmly re-state the Federal Reserve’s position. Her very dovish comments have finally led the markets to conclude that near-term rate increases will not happen and they have restored a sense of calm. It would seem that the blindingly obvious has to be repeated a multiplicity of times in order to penetrate the grey matter of some financial journalists and market-makers.
In fact, the Fed funds futures are not even factoring in an interest rate rise until December of this year indicating that the Fed’s June meeting will be yet another non-event.
On 31st March the FTSE 100 closed at 6174 (a fall of -1.09% for the 2016 year to date).
By comparison the Quotidian Fund’s valuation at the end of March is down by –15.43% for the year to date; that reflects a positive return for March of +7.47%. As indicated in our most recent reports, we are entirely confident in the constituent parts of our current portfolio and anticipate positive progress to continue further.
The remaining headwind to our upward momentum this year has been the muted performance from our holdings in the Pharmaceutical and Biotech sector. Historically this sector has been highly successful for us for many years but has been subjected to unjustified negativity since the start of this year.
However, the tide is now turning in our favour again which underpins the confidence I mention above. A detailed summary of our liking for this particular sector was contained in my October 2015 monthly report.
On the horizon, of course, the EU referendum is looming in Britain and that is likely to provoke short-term uncertainty the UK markets.
The quality of the debate between the ‘remain’ and ‘leave’ factions has thus far been depressingly low to non-existent. The status quo side seems to be content with scare tactics underpinned by questionable figures (much of which have been stage-managed or belatedly seen to be based on fallacy) whilst the ‘enough is enough’ campaign is fractured and seemingly incapable of creating a coherent strategy.
No serious mention has yet been made of Europe’s disastrous and continuing migrant crisis and its economic, social and safety implications. Neither has there been any focus on the inherent problems of the common European currency and its adverse economic effects, particularly on unemployment.
One of the few facts that we can rely on from official and dependable sources is that the latest UK trade figures show a record deficit with the EU. They confirm a trade deficit of £8.10 billion in January alone and of £23 billion in the last three months. That would appear to indicate that the UK is a far more important trading partner to the EU than the EU is to the UK. So much for the ‘vital importance’ of the free trade link with the EU that has been trumpeted by the pro-EU faction.
In light of just those trade numbers (let alone the ongoing migrant issues and the Euro with its ‘one size fits all’ philosophy) one questions why the UK could or should feel the need to remain in an excessively bureaucratic, anti-democratic, demonstrably corrupt and economically bankrupt alliance.
First quarter results began to filter through from 10th April onwards and the initial signs were positive. As the results season gathered pace the number of positive earnings and profit ‘surprises’ injected a little more confidence into equity valuations. Indeed, by the third week of the month the FTSE came into positive territory for the first time this year as it rose above its 31st December 2015 closing level. Similarly, major markets around the world rallied to 2016 year highs. However, this uplift was not to last.
The Bank of Japan had been expected to announce a further round of financial ‘stimulus’ having pledged earlier this year to do anything and everything to eliminate that nation’s economic ills. Japan’s economy is on the cusp of slipping back into recession for the fifth time since the Great Recession of 2008/9 and, in terms of deflation, Japanese prices dropped by another 0.30% in March (their largest decline in three years).
Indeed, earlier this year the BoJ had continued its Quantitative Easing programme by printing hundreds of trillions of yen to buy up everything from government bonds to stock market ETFs to Real Estate Investment Trusts. In addition, having kept interest rates at near zero for many years it cut them into negative territory in January.
In the event, overnight on 27/28th April the BoJ presented global markets with a very unwelcome shock. It didn’t boost the size of its 80 trillion yen-per-year QE program as had been fully expected, it didn’t lower its negative -0.1% benchmark rate any further and it didn’t buy even more equity ETFs in order to maintain stock-market support (in other words, it didn’t continue to artificially manipulate the Japanese market higher).
As a result, the Japanese benchmark equity index (the Nikkei Stock Average) initially dropped by 3.6% and continued to fall, putting substantial downward pressure on worldwide markets throughout 28th and 29th April. The demonstrable failure of QE and the policy of negative interest rates in Japan has called into question the efficacy of similar stimulus programmes elsewhere (particularly in Europe)
Typically and tediously global markets reacted in knee-jerk negative fashion to the BoJ’s lack of action and we were treated to yet another bout of wild short-term swings in the US and European markets. These were exacerbated by the fact that, with the long holiday weekend upon us, market makers preferred to mark prices substantially down and pause for thought until trading desks resume after the May Day holiday.
At 30th April, of the 325 companies from the S&P 500 that had thus far reported their results, 249 had produced positive figures in excess of market expectations. Indications on the flow of future earnings were largely upbeat too and so the likelihood is that this should help to lift equity valuations again when markets re-open.
On 30th April the FTSE 100 closed at 6241.89 a fall of -0.01% for the 2016 year to date.
By comparison the Quotidian Fund’s valuation at the end of April is –14.72% for the year to date (which reflects a positive investment return for April of +0.84% (a figure which had been much higher before the temporary markdown in the last two days of the month).
On the horizon, of course, the EU referendum is looming in Britain and that is likely to provoke further short-term uncertainty and volatility in the UK stock-market. With that in mind we took the opportunity whilst FTSE was in positive territory for the year to close our holdings in that at a profit (albeit a small profit). We will be seeking to re-establish holdings in the UK market when an appropriate prospect for profit arises.
The debate between the ‘remain’ and ‘leave’ factions continues to be turgid with neither side seemingly prepared to focus on the real issues. As the outcome of the referendum will become the main focus for markets over the next seven weeks we feel it appropriate to consider and comment herein on the relevant issues and facts.
In our view the main issues of importance to the UK and its voters are:
- The impact on UK trade and commerce of the decision either to leave the EU or to remain.
- The financial and social impact on the UK of unrestricted immigration both now and in the longer term
- The effect of an exit vote on Britain’s defence and security.
Taking each of these in turn:
I highlighted in last month’s report the significant trade imbalance between the UK and our EU trading partners (which is hugely unfavourable for the UK). We are told that the EU market represents approximately 44% of the UK’s trade. What has not been made clear is that this figure has actually been declining for many years; where once the EU was responsible for around 55% of the UK’s trade that position has slowly been eroded.
It obviously follows that approximately 56% of the UK’s trade is with markets outside the EU bloc.
Sadly, the leaders of the ‘remain’ faction have been more intent on trying to produce scare stories rather than any worthwhile information or debate. The quite ridiculous and perfidious pamphlet produced last week by George Osborne epitomises their blatantly one-eyed approach. Their tactics gave every impression of having started with their desired conclusion and then working backwards making use of manipulated assumptions and deliberately distorted figures (whilst also ignoring any positive data) in order to arrive at their required answer.
On the opposite side of the debate, last week a group of serious and highly respected economists produced a much more credible report which concluded that the UK (if free of the EU’s trade barriers) would benefit from a 4% increase in GDP.
Another report produced and signed by 110 competent and respected figures in the financial world stated that London would actually strengthen its lead as the world’s biggest financial hub if the UK did exit from the EU. It asserted that increasing regulation from Brussels posed a significant threat to Britain’s financial services industry and that the UK would be better off outside the EU. We are under no illusion that the EU would prefer to see Frankfurt replace London as its financial centre.
No mention whatsoever has yet been made of the trading opportunities inherent in the British Commonwealth countries. This group of 53 sovereign countries (who are members of the Commonwealth by choice not by diktat) comprises a population of 2,357,512,000 people and growing whereas the EU bloc has a current population of 508,191,116. Even before we consider the opportunities for trade presented by the USA, China and other emerging markets we have an enormous untapped trading resource within the Commonwealth.
Despite Mr Obama’s interference with the referendum process at the beginning of the month, there is not in fact a formal trading agreement between the USA and the EU. Such an agreement is in the course of negotiation but trade between these two blocs has been happily conducted for many years under the aegis of the World Trade Organisation (which exists to support free trade globally). Obama’s comments were simply politically motivated, lazy and self-interested.
No serious mention has yet been made of Europe’s disastrous and continuing migrant crisis and its economic, social and safety implications. Neither has there been any focus on the inherent problems of the common European currency and its adverse economic effects, particularly on unemployment.
In its blatant attempt to construct a spurious financial case to support the ‘remain’ campaign the Treasury’s disingenuous pamphlet revealed the Government’s prediction of the number of immigrants expected to arrive in the UK by 2030. According to Osborne’s own forecast contained in that brochure this figure was stated to be 3.3 million people (much higher than we have previously been led to believe). To put it another way, that represents an increase of 5% to the UK’s current population (even before taking into account the additional natural increase in numbers with births outnumbering deaths) over the next 14 years.
We can clearly see that the UK’s national facilities are already under severe pressure and stretched to breaking point. One shudders to think of the impact that such a quantum leap in population will have on the NHS, our education system, the UK’s transport structure, defence, law and order, housing facilities and food production. Perhaps it is not a surprise that the government prefers to deflect attention away from the eye-watering levels of increased taxation that would be required to support Britain’s infrastructure in the event of such an influx of people. Common sense and security demand the return of border controls.
Since the end of the Second World War Britain’s defence has been secured through our attachment to NATO. It has certainly not been enhanced through our connection to the EU. Leaving the EU has no bearing upon our continued affiliation to NATO.
On the domestic front, official figures published in April by the Office of National Statistics indicated that violent crime in the UK rose by 27% in 2015. Of the 43 police forces around the country, all recorded a rise and 41 of them showed a double-digit increase. This situation is unlikely to be improved if we see an uncontrolled increase in population.
Despite the scare-mongering and the level of deception masquerading as ‘facts’ emanating from the ‘remain’ campaign, the latest opinion polls suggest that the ‘remain’ side stands at just 43% of the vote, the ‘leave’ group at 40% and the ‘undecideds’ at 17%.
Forty years of experience have shown us that the EU is intrinsically undemocratic, financially incontinent and completely unwilling to change. Leaving the EU would no doubt cause some short-term economic turbulence but the issues set out above make the case for Britain to leave the EU ever more compelling.
Winston Churchill has been deliberately misquoted in the course of this campaign in the hope of supporting the ‘remain’ case. What he actually said was “We are with Europe but not of it. If Britain must choose between Europe and the open sea, she must always choose the open sea”.
The EU is suffering from the worst income inequality between member nations in recent memory. Whilst this is not a new phenomenon the income gap between richer EU nations like Germany and poorer countries like Spain, Greece, and Portugal has now expanded to an alarming degree.
In 2009, in US$ terms the annual income per capita was:
- A sizeable $41,890 in Germany, compared to
- A much lower $32,412 in Spain
- A meager $29,819 in Greece
- And a miserly $23,122 in Portugal
Over the past five years, though, the gap has become far, far worse. Income per capita has now:
- Risen by a robust 13.9% in Germany but
- Fallen by 4.2% in Portugal
- Deteriorated by 8.1% in Spain, and
- Plummeted by 27.6% in Greece
These figures clearly confirm the fact that some of the richer European countries have managed to recover from the Great Recession but many of the poorer member countries have fallen even further into the abyss.
In addition to generating resentment and disdain between social classes around Europe this trend has fomented envy and anger among member nations of the European Union. It is one of the forces that has driven migration from poorer to richer member nations and it sets the stage for the eventual political disintegration of the European Union itself.
As these imbalances become worse the rising tide of anti-EU sentiment sweeping across the Continent is now reaching critical mass. In evidence of that assertion:
In Hungary, the right-wing nationalist conservative Fidesz party enjoys an absolute majority under the leadership of Victor Orban and continues to have record-high popular support in 2016. Today the party’s agenda is viewed as so extreme by those in Brussels that, according to EU foreign policy chief Javier Solana, if Hungary were applying for EU membership today it would be flatly rejected.
In Poland, the fiercely anti-EU Law and Justice Party (PiS) has gained an absolute majority in parliamentary elections in October 2015.
In France, the National Front under Marine Le Pen emerged as one of the strongest political powers, taking more votes in 2015 local elections than the Republicans or Socialists. Again, greater independence from the EU is their primary goal.
In the Netherlands, the Freedom Party under Geert Wilders has vowed to immediately pull the country out of the EU. Although this platform was rejected by voters in 2014, Wilders now leads in the Dutch polls ahead of elections next year thus giving him the ammunition to flatly declare that the “EU is finished”.
In Austria, the Freiheitliche Partei Österreichs (FPÖ) is also staunchly anti-EU. In this year’s first-round election for President the FPÖ’s Norbert Hofer won comfortably with over 36% of the vote.
In Germany, the newly emergent Alternative für Deutschland (AfD) now has more popular support than at any time in its history and now stands just five percentage points behind the centrist Social Democrats. Until recently, although the party was staunchly against the euro, it was ambivalent about the EU. But now their new manifesto is very clear: To abolish the EU forever.
In the UK, the campaign to exit the European Union now enters its climactic phase leading up to the June 23rd vote. Whether the UK decides to stay or leave we will no doubt continue to see an increase in anti-EU opinion all around Europe and, barring a miracle, the days are numbered for the European Union as we know it today.
Does the UK want to remain to the bitter end or, by leaving, does it then want to lead the way forward to a truly democratic European Economic Union where free trade, protected borders and freedom of choice replace the anti-democratic and faintly absurd notion of a Federal Europe ruled by unelected and unaccountable bureaucrats.
Performance and Summary
On 31st May the FTSE 100 closed at 6230.79 (a fall of -0.18% for the year to date).
By comparison the Quotidian Fund’s valuation at 31st May shows a positive investment return for the month of May of +6.25% and for the year to date is now –9.73%. Despite equity-market headwinds, the Fund continues its sharp recovery from a glum start to the year.
The two most obvious stock-market sensitive issues in June will be the Federal Reserve decision on US interest rates at its mid-month meeting and, of course, the outcome of the UK referendum on EU membership.
It will no doubt come as a surprise to regular readers that (for the reasons set out above and also in my April report) my strong view on the referendum is that it’s time for Britain to say adieu to the EU (adieu is much more permanent that simply saying Eu Revoir!). The European Union as it currently exists is a cesspool of rotten politics, inept leaders and a badly constructed monetary system which is the central cause of so many of the EU’s problems (and that was flawed from its very outset).We continue to believe that US interest rate will remain unchanged until later in the year and that, whichever way the UK decides to go, any knee-jerk effect on the stock-market here will be transient. Far more pertinently, growth of M1 money supply in the USA has accelerated to 7.8% and that, together with increasing monetary growth worldwide, is usually a harbinger of better economic times.
The financial services industry is founded on catering for the risks of either dying too soon or living too long.The financial effects of dying too soon can be evaluated and the risk then covered through the use of life assurance.
The issues of living too long are more complex and the real risks are often overlooked by even the most sophisticated investors.
Investors generally have an intuitive grasp of what they perceive as investment risk but in many cases that perception is based simply on the fear of making a definable financial loss.
Rarely does the typical investor take into account the far more serious but much less obvious risks associated with their own life expectancy and the onerous erosive effect of inflation.
With improvements in medical science (particularly over the past twenty five years) a man who has attained the age of 60 nowadays has a life expectancy of 21 years. Contrast that to the situation 25 years ago when the life expectancy of a 60 year old was just 16 years. That is a substantial increase and brings with it a considerable increase in risk.
Developing that theme, a man of 65 now has a life expectancy of 17 years whereas in 1987 it was 13 years and a man of 70 has an expected 14 years ahead of him as opposed to the 10 years he could have expected to live for in 1987.
A similar situation pertains for female lives. A woman of 60 today has a life expectancy of 24 years (up from 20 in the late 1980’s), whilst a 65 year old female would now be expected to survive for another 20 years (up from 17) and a 70 year old has an expectation of 16 more years (increased from 13).
Continuing improvements in research and medical care will further extend the average life expectancy of those living in the developed world.
Quite simply we are living much longer and the finances we have built up will be required to see us through a longer period of time than we may have originally planned for.
Whilst this alone poses a real risk and a grave threat to our personal financial stability and security that risk is magnified much further when we take into account the effect of inflation.
Even a modest level of future inflation has a severely detrimental effect of the real value of our capital and income. We are told that inflation in the UK is currently running at just under 3% per annum.
If it continues at that level then over 5 years it would reduce the real value of our finances by 14%. Over 10 years the effect is more onerous and translates to a reduction in value of 26% and over 15 years the impact is an even more considerable fall of 37%.
Putting that into monetary terms, £100 at today’s values would effectively be worth £85 in 5 years time, £73 in 10 years and just £63 after 15 years of relatively low inflation. Of course, if the rate of inflation rises then these falls in purchasing power become even more significant.
The combined impact of increased life expectancy and future inflation pose a very substantial threat to one’s financial wellbeing and yet these significant risks are all too often overlooked when investment decisions are being made.
An investor opting to take what he believes to be a low risk investment (simply because he is fearful of making an investment loss) is actually leaving himself exposed to the much greater ‘hidden’ risks of extended life expectancy and inflation. As the figures above illustrate, the investor would be in grave danger of unwittingly making his financial position much worse. Sleepwalking towards financial disaster would not be too strong a description of this scenario.
Decision making in relation to investment
It has long been proven that investment in equities has been the most efficient way to maintain pace with inflation over a period of time. The importance of maintaining the integrity of your income and capital cannot be overstated, particularly in light of increased life expectancy and the effect of future inflation.
As has been demonstrated above, inflation erodes the nominal value of your capital and so it is essential to maintain the value of your wealth and the purchasing power that flows from it.
In order to do so it is necessary for your investment manager to try to preserve and grow the real value of your assets through a measured exposure to investment risk. The risks associated with stockmarket investment can be controlled through astute selection and consistent monitoring.
At Quotidian we only make investments where and when we feel that the potential for profit is compelling and we scrutinise our investment decisions on a daily basis.
We seek to invest in assets that have strong liquidity and are readily tradable. We apply a combination of technical analysis and fundamental analysis in arriving at our investment decisions. In so doing, we seek to maximise investment returns whilst controlling exposure to equity risk.
As part of our risk control process we are content to switch into money for extended periods if markets are relentlessly negative and less likely to produce a profit commensurate to risk.
We strongly recommend that investors combat the detrimental risks of longer life expectancy and inflation by including selective and controlled exposure to equities into a well planned investment portfolio.
Deception masquerading as ‘facts’ was the hallmark of the ‘remain’ campaign.
The quality of the debate between the ‘remain’ and ‘leave’ factions was depressingly low to non-existent. The status quo side seemed to be content with scare tactics underpinned by questionable figures (much of which had been stage-managed or belatedly seen to be based on fallacy) whilst the ‘enough is enough’ campaign was fractured and seemingly incapable of creating a coherent strategy.
No serious mention was been made of Europe’s disastrous and continuing migrant crisis and its economic, social and safety implications. Neither was there any focus on the inherent problems of the common European currency and its adverse economic effects, particularly on unemployment.
In light of just the trade numbers alone (and setting aside the need for democracy, the ongoing migrant issues and the Euro with its ‘one size fits all’ philosophy) one questions why the UK could or should feel the need to remain in an excessively bureaucratic, anti-democratic, demonstrably corrupt and economically bankrupt alliance.
Forty years of experience have shown us that the European Union is intrinsically undemocratic, financially incontinent and deliberately unwilling to change. Leaving the EU would no doubt cause some short-term economic turbulence but the issues set out above make the case for Britain to leave the EU ever more compelling.
The European Union as it currently exists is a cesspool of rotten politics, inept leaders and a badly constructed monetary system which is the central cause of so many of the EU’s problems (and that was flawed from its very outset).
Does the UK want to remain to the bitter end or, by leaving, does it then want to lead the way forward to a truly democratic European Economic Union where free trade, protected borders and freedom of choice will replace the anti-democratic and faintly absurd notion of a Federal Europe ruled by unelected and unaccountable bureaucrats.
Winston Churchill has been purposely misquoted in the course of this campaign in the hope of supporting the ‘remain’ case. What he actually said was “We are with Europe but not of it. If Britain must choose between Europe and the open sea, she must always choose the open sea”.
Methods of leaving the EU – Article 50 and beyond
The first step is to invoke Article 50 of the Treaty of Lisbon. The UK controls the timing of that in entirety. Whilst the EU might wish to rush things (in order to avoid any contagion of Brexit to other countries) it is entirely in the UK’s gift as to when that button should be pressed.
We are already in the EEA (European Economic Area) which is where (once outside the EU) we must choose to remain. This, together with an application to join the European Free Trade Area (EFTA) gives the UK an immediate solution to the ‘access to the single market’ trading problem.
Furthermore, under Article 112 of the EEA Agreement, we also have the unilateral right to claim a partial opt-out from the EU’s ‘freedom of movement’ rules. This would allow us to set up a quota system to control immigration from other EU countries.
However, the EU will no doubt seek to press us into going along with their much-touted plans for a ‘two-tier’ Europe which would leave the Eurozone countries united and centralized and with the UK and other non-euro nations sitting on the sidelines (and possibly joined by ‘neighbouring’ countries such as Turkey and Morocco).
This will be portrayed by the EU as an attractive compromise whereas it is, in fact, a highly deceptive strategy. It would leave the UK still in the EU but as a second-class member with all the disadvantages that we voted to extract ourselves from. We would still be subject to much of the ‘supranational’ system we voted to escape from and it would leave us even worse off than we were.
The most disastrous option is that we could reach the end of our two-year negotiation period without any agreement having been reached. Bear in mind that the EU have already taken 10 years to negotiate a trade deal with the USA and still there is no agreement in sight. Likewise, negotiations with India were abandoned after nine years of pointless wrangling and inability to make a decision by the EU end of things. The impossibility of 28 countries reaching accord is palpably obvious when one looks at the pigs-breakfast they have made of trade negotiations thus far.
Finally, on invoking Article 50, the UK should immediately apply for an extension to the 2 year negotiating period (as the rules allow us to do) in order to avoid the absurd situation where, after leaving the EU but failing to reach an acceptable exit agreement within 2 years, the remaining EU counties could sell to us but we would no longer have the necessary paperwork to sell to them!
We must hope that our negotiators are capable and well-informed enough to negotiate the labyrinth.
Following the years of global depression from 2007 onwards corporate profit margins have frequently been shored-up by a combination of:
- A premeditated lack of investment in capital equipment
- Record levels of share buybacks by public companies
However, there is a limit to the enduring effectiveness of profit growth using just these measures. Financial engineering of this sort eventually suffers from diminishing returns and so growth in sales is vital in order to boost real long-term earnings growth.
From an investment perspective it thus remains critically important to focus on which sectors and individual stocks are still capable of growing their sales and thereby their profits. It is equally important, of course, to avoid those companies and sectors which cannot or will not do so.
With that in mind, the sectors that we expect to contribute the most and the least to third-quarter results and thereafter are:
The good: Healthcare stocks are expected to report increasing sales up 8% on average from a year ago with earnings per share advancing over 6%. Consumer Goods and Services are also expected to deliver earnings increasing by 5% for the quarter with profit growth of 4%. Technology stocks are the other positive sector.
The bad: Earnings growth for S&P 500 Industrial Sector stocks has been declining for the past two quarters (hand in glove with weaknesses in energy and commodity prices) and profits in this sector are anticipated to decline by over 5% in the third quarter.
The ugly: The worst offenders this quarter will continue to be Energy and Basic Materials stocks. We anticipate that falling oil and gas prices together with continuing declines in many other commodities will bring about dismal results in these sectors both in this quarter and beyond. Energy stocks in the S&P 500 are expected to post a 64% earnings decline on average this quarter while Basic Materials profits are forecast to drop by 18.5%.
The Quotidian Fund places a considerable focus on the Healthcare, Pharmaceutical and Biotechnology sector.
The attraction of this sector from an investment viewpoint is that it has:
- A long history of relative security and reliable performance;
- Projections of future profits are consistently robust;
- Takeovers are commonplace and so there is potential for an occasional huge increase in share prices;
- Also, on a non-financial but equally important basis, by supporting the development of new medicines we contribute towards a valuable social benefit too.
In the pharmaceutical and biotech sector there are broadly two styles of business model:
- Companies that spend billions on research & development to produce new drugs
- Organisations that are simply opportunistic and seek to buy the rights to various drugs which are towards the end of their patent protection period and then ramp up their prices to maximise short-term gains.
We fish in the former pond but not the latter. Companies who create new drugs are able to acquire patent protection on these products which allows them to recoup the costs of development and rightly gain worthwhile profit from their enterprise. Typically, patent protection lasts for 10 years following which any drug can be copied and marketed by all and sundry. It follows that the first ten years from launch of a newly approved drug are the most important and lucrative from the innovating company’s viewpoint.
Opportunistic organisations do have their place as they allow those who are focused on research and development to capitalize the inherent value remaining in those drugs that are approaching the end of their patent protected period and thus direct that value into future R & D.
Companies like Valeant Pharmaceuticals (a Canadian company) are increasingly coming under fire. Their business model focuses on buying well established drugs and then hiking the prices of those drugs massively. They then distributing the resultant profits to management and shareholders rather than investing in Research & Development.
For example, we note that Valeant quadrupled the price of a drug called Cuprimine. The effect was to drive up the cost of just one patient’s treatment to $35,000 a month – a five-fold increase largely covered by Medicare (thus the political hand-wringing and backlash in the USA).
In addition, late last month the industry found another pantomime villain in the form of Martin Shkreli. His company, Turing Pharmaceuticals, bought the rights to a drug called Daraprim which treats an infection called toxoplasmosis. Turing then proceeded to ramp up the price of that drug by more than 5000%.
There are many sides to this issue but soaring drug prices raise widespread ethical, political and social concerns. The current negative publicity has clearly put short-term downside pressure on pharmaceutical stocks in general and biotech stocks in particular.
This is what gave rise to Hillary Clinton’s recent knee-jerk reaction and politically self-interested ‘soundbite’ last month (as covered in my September monthly report). As a consequence of that investors have been concerned that the US government could introduce price controls or other punitive measures on pharmaceutical and biotech companies.
In our opinion this action is highly unlikely because to do so would stifle the development of new drugs and treatments which would, of course, be politically unpopular and morally bankrupt. Innovative companies spend billions on R&D to take a drug concept through the various stages of rigorous testing in order to get FDA approval. Naturally therefore their breakthrough drugs need to be sold at an appropriate and profitable price. Political interference has acted as a drag on the sector at this point in time but we believe that this effect will be short-lived.
On 31st October the FTSE 100 closed at 6361 (which equates to -3.12% for 2015 to date). This represents an uplift of 4.94% during its partial recovery month of October.
By comparison the Quotidian Fund at the end of October was +18.89% for the year to date, having increased in value by +8.88% in the month. We currently stand exactly 22.00% ahead of our benchmark (being the FTSE100 index).
During this exceptional month we have regained virtually all the value that had been marked down during the lacklustre and volatile months of August and September. It is vitally essential not to panic and risk making emotional decisions when markets go through such potentially unnerving periods of negativity.
Our performance in October partly reflects the bounce-back effect of major markets after two months of profoundly negative market correction. To a greater extent though it is a reflection of the positive and considered actions we took at the low points in markets to increase our holdings in those companies we trust whilst their prices had been oversold and, in addition, to building up well-thought-out new holdings up at fire-sale prices.
It has been helpful that the third quarter reporting season (thus far roughly 60% of the companies which form the S&P 500 index have released their latest figures) has produced far more positive surprises than analysts had expected. Future sales and earnings estimates have also been generally encouraging.
Stockmarkets were given further positive momentum in the last ten days of October by the European Central Bank’s announcement that it intends to expand and extend its quantitative easing programme and also by the Peoples Bank of China’s action in reducing interest rates there by a further 0.25% whilst simultaneously easing liquidity requirements for their banks.
An additional air of positivity was engendered when the Federal Reserve issued an upbeat report in respect of the US economy on 28th October and suggested that they might now introduce their long expected interest rate increase in December. As anticipated in our September report, this has been well received by markets.
We are under no illusion that the global economy generally remains in very poor shape with worrying levels of corporate and sovereign indebtedness that by any recognised economic measure are beyond parody.
However, there are always individual companies and sectors that rise above the prevailing gloom and continue to produce relatively reliable profits on a regular basis. These, of course, are where we seek to focus our efforts.
As indicted at the end of last month’s Quotidian briefing, the most important economic and market-moving news in September was the Federal Reserve’s decision on US interest rates at their mid-month meeting.
According to market commentators, downward pressure on equity valuations in August had been aggravated by concerns that the Federal Reserve would increase US interest rates for the first time since 2006 at this month’s meeting.
In the event, the Fed decided to leave interest rates unchanged and one would be forgiven for thinking that that was good news. However, the same voices that had predicted the end of the world if rates had been increased now changed their tune and put a profoundly negative spin on the decision to postpone any rate rise. Having gently recovered and moved upwards again in the early weeks of September, the market was hit once more by a tsunami of negativity following the Fed’s announcement.
The explanations for this irrational reaction varied between:
- It must mean that the US economy is a lot weaker than the Fed is letting on.
- The Fed is worried about making the financial and political turmoil in Europe and the Middle East even worse (with potential knock-on effects on the US economy).
- The Fed doesn’t want to make the US dollar even stronger and thereby make US goods and services even less competitive.
- As interest rates rise so the cost of repaying debts will rise for the already heavily leveraged governments in Europe and the Far East and the Fed doesn’t want to potentially cause a new and even larger global sovereign-debt crisis.
Whilst some of these assertions are no more than guesswork and others may have a degree of merit they are not, in our view, sufficiently persuasive to justify the major equity downgrading that then occurred.
It is worth remembering that the Federal Reserve has two main purposes;
Firstly, its role is to maintain the unemployment rate in America at or close to its long-term average of 4.9% (the official unemployment rate in the USA is currently 5.1% having been at nearly 10% as recently as 2012).
Secondly, the Fed is responsible for keeping inflation under control (and that is deemed to mean at an annual rate of 2% on average). Inflation in the US is currently lower than that figure and the Fed would like it to increase to their target range.
Janet Yellen (the Federal Reserve Chair) is, of course, well aware of the pervasive impact on society generally (and particularly those who are reliant on pensions and savings to generate their income) of over six years of zero interest rates. She would clearly like to make a relatively modest increase in interest rates at this stage of the economic cycle and it is very likely that rates will increase marginally before the end of 2015. Given what has happened over the last six weeks this should now be received as a positive move by the equity markets.
One important effect of this long period of low interest rates has been the impact on income generated by pensioners. Many investors (especially the elderly) have been prepared to take a much higher risk profile in their investment strategy in their search for worthwhile returns. This has been and will continue to be another positive for stock-markets.
However the latest Chinese economic data issued towards the end of September wasn’t encouraging; new orders are falling, output is falling, employment is falling, and prices are falling. In particular, China’s Purchasing Managers Index sank to a reading of 47 in September from 47.3 in August and now sits at its lowest since March 2009. As a consequence, global equities are continuing to fluctuate wildly in the short term and have contributed to the current air of pessimism.
Up until now the Healthcare and Biotech sectors have been areas of the market which have remained buoyant and immune from pricing gyrations. It is no coincidence that the Quotidian Fund has been focused therein. However, in the last week of September even that segment of the market was very aggressively marked down.
We saw seven successive days of downward revision of prices in Healthcare and Biotech shares and three of those days were very steeply negative. As a result, we believe that stocks in those sectors are now grossly oversold and we expect a strong rally in the weeks and months ahead.
On 30th September the FTSE 100 closed at 6248 (which equates to – 7.68% for 2015 to date). This represents a decline of 2.98% in the hyper-volatile month of September.
By comparison the Quotidian Fund at the end of September was + 9.19% for the year to date, having declined 4.90% in the month. Despite this downward revaluation, we remain 16.88% ahead of our benchmark (the FTSE100 index).
In October the third-quarter earnings season will be upon us and it will be nice to get back to talking about products (supply and demand), profitability and economic reality instead of political matters. Many analysts have lowered their forecasts for corporate profits and earnings per share. If the reality turns out to exceed these forecasts then it will add another much- needed boost to equity valuations.
We therefore believe that the FTSE will end this year significantly higher than its current subdued level and much closer to the 7000 point level it last achieved in April. Similarly, we anticipate that the US market (and especially the Healthcare and Biotech sectors) will move higher from here.
As indicted at the end of last month’s Quotidian briefing, the most important economic and market-moving news in September was the Federal Reserve’s decision on US interest rates at their mid-month meeting.
According to market commentators, downward pressure on equity valuations in August had been aggravated by concerns that the Federal Reserve would increase US interest rates for the first time since 2006 at this month’s meeting.
In the event, the Fed decided to leave interest rates unchanged and one would be forgiven for thinking that that was good news. However, the same siren voices that had predicted the end of the world if rates had been increased now changed their tune and put a profoundly negative spin on the decision to postpone any rate rise. Having gently recovered and moved upwards again in the early weeks of September, the market was hit once more by a tsunami of negativity following the Fed’s announcement.
The explanations for this irrational reaction varied between:
- It must mean that the US economy is a lot weaker than the Fed is letting on.
- The Fed is worried about making the financial and political turmoil in Europe and the Middle East even worse (with potential knock-on effects on the US economy).
- The Fed doesn’t want to make the US dollar even stronger and thereby make US goods and services even less competitive.
- As interest rates rise so the cost of repaying debts will rise for the already heavily leveraged governments in Europe and the Far East and the Fed doesn’t want to potentially cause a new and even larger global sovereign-debt crisis.
Whilst some of these assertions are no more than guesswork and others may have a degree of merit they are not, in our view, sufficiently persuasive to justify the major equity downgrading that then occurred. However, when equity markets are in determinedly negative mode then bad news is emphasised or created whilst good news is ignored.
It is worth remembering that the Federal Reserve has two main purpose;
Firstly, its role is to maintain the unemployment rate in America at or close to its long-term average of 4.9% (the official unemployment rate in the USA is currently 5.1% having been at nearly 10% as recently as 2012).
Secondly, the Fed is responsible for keeping inflation under control (and that is deemed to mean at an annual rate of 2% on average). Inflation in the US is currently lower than that figure and the Fed would like it to increase to their target range.
Janet Yellen (the Federal Reserve chairman) is, of course, well aware of the pervasive impact on society generally (and particularly those who are reliant on pensions and savings to generate their income) of over six years of zero interest rates.
She would clearly like to make a relatively modest increase in interest rates at this stage of the economic cycle and it is very likely that rates will increase marginally before the end of 2015. Given what has happened over the last six weeks this should now be received as a positive move by the equity markets.
One important effect of this long period of interest rates has been to impact on income generated by pensioners. Many investors (especially the elderly) have been prepared to take a much higher risk profile in their investment strategy in their search for worthwhile returns. This has been and will continue to be another positive for stock-markets.
The latest Chinese economic data issued towards the end of September wasn’t encouraging; new orders are falling, output is falling, employment is falling, and prices are falling. In particular, China’s Purchasing Managers Index sank to a reading of 47 in September from 47.3 in August and now sits at its lowest since March 2009.
As a consequence, global equities are continuing to fluctuate wildly in the short term and have contributed to the current air of pessimism. As has been said before in our monthly musings, though, in the longer term numbers from China need to be taken with a large pinch of salt.
On 30th September the FTSE 100 closed at 6248 (which equates to -7.68% for 2015 to date). This represents a decline of 2.98% in the hyper-volatile month of September.
By comparison the Quotidian Fund at the end of September was +9.19% for the year to date, having declined 4.90% in the month. Despite this downward revaluation, we remain in positive territory for 2015 (which is more than can now be said for any of the global equity markets) and 16.88% ahead of our benchmark (being the FTSE100 index).
Up until now the Healthcare and Biotech sectors have been areas of the market which have remained buoyant and immune from pricing gyrations. It is no coincidence the the Quotidian Fund has been focused therein. However, in the last week of September even that segment of the market was very aggressively marked down.
That negative tone was set in train by virtue of a tweet issued by Hillary Clinton who declared that she intended to introduce a plan to reduce and limit the prices of medicinal drugs. There is an inherent absurdity in that comment and the medium used to transmit it but that did not stop immediate, substantial and sustained downward pressure on equity valuations in the Healthcare and Biotech sectors.
The irrational nature of this reaction is that support for Clinton’s campaign to become the Democratic party’s candidate in next year’s US general election is fading badly (which might explain the motivation behind what she imagines to be crowd-pleasing initiatives such as this statement on drug pricing). More popular candidates have emerged whose momentum is currently swamping the Clinton bandwagon and the Democratic nomination is now looking a very close call. Even if she does eventually prevail within the Democratic party, her inept intervention over Healthcare and Biotech has damaged her credibility with the business world and harmed the prospect of the Democrats defeating the Republicans in next year’s race for the White House.
Her comments can thus be seen as no more than self-serving political waffle but they have had a profound but transitory effect on market valuations. We saw seven successive days of downward revision of prices in Healthcare and Biotech shares and three of those days were very steeply negative. As a result, we believe that stocks in those sectors are now grossly oversold and we expect a strong rally in the weeks and months ahead.
In October the third-quarter earnings season will be upon us and it will be nice to get back to talking about products (supply and demand), profitability and economic reality instead of political matters. Many analysts have lowered their forecasts for corporate profits and earnings per share. If the reality turns out to exceed these ultra-conservative forecasts then it will add another much-needed boost to equity valuations.
We therefore believe that the FTSE will end this year significantly higher than its current subdued level and much closer to the 7000+ point it last achieved in April. Similarly, we anticipate that the US market (and especially the Healthcare and Biotech sectors) will move higher from here.
Some comfort can be drawn from the fact that the latest of these oscillations was at least founded on an economic basis in the form of a completely unexpected move by the Swiss National Bank.
Following its decision in December to reduce their interest rate to minus 0.50% (the rationale for which was explained in our December report) the SNB went a step further on 16th January and reduced that rate even further to minus 0.75%. This in isolation would not have been a market shaker but simultaneously (and completely out of the blue) the SNB also removed the long-standing ‘peg’ between the Swiss Franc and the Euro.
That move came as a complete surprise to markets because the SNB had been maintaining a minimum exchange level of 1.20 francs to the euro since September 2011. It had also promised that it would defend that peg “with utmost determination.”
Abandoning the ‘peg’ was therefore a move that shocked traders all around the world and what followed has never been seen before in the currency markets.
Their supposed aim was to prevent Swiss deflation but the SNB had had to buy billions of euros in order to maintain the ‘peg’ and print Swiss Francs in order to do so. But, with the well-touted prospect of Quantitative Easing set to be introduced by the European Central Bank during January with the obvious side-effect that would have on the Euro itself, Swiss policymakers realized that they just could not keep defending the 1.20 level and so they (quite rightly) threw in the towel.
The result was swift and severe. The euro plunged 40% in value against the Swiss Franc in little more than a blink of the eye.
At the same time the Swiss stock market also fell more than 10 percent in a matter of minutes amid fears that the move would eviscerate earnings for Swiss exporters. This fall was mimicked in equity markets globally.
Taking the FTSE as an example, at 10:28am on 16th January (the time at which SNB’s announcement was made) the main UK index was up around 1.50% for the day. By 10:30am the FTSE was down roughly 1.50%.
Thankfully, the usual round of data releases from the US in January helped to temper market pessimism and nerves.
On the unemployment front the U.S. economy added another 252,000 jobs in December 2014 (beating the widely anticipated forecast of 240,000). In addition, November’s reading was revised higher to 353,000 and October’s number was revised upwards to 261,000.
The 2014 overall gain of 2.95 million jobs was the highest of any year since 1999.
The US unemployment rate fell again in December to 5.6 percent from 5.8 percent in November and currently is at its best reading since June 2008.
On 22nd January Mario Draghi eventually delivered the long awaited statement from the European Central Bank in respect of its Quantitative Easing initiative. Little of his announcement was new or surprising simply because Francois Hollande, in a speech made four days earlier, had already let the cat entirely out of the bag (rarely has the tale of the ‘wide-mouthed frog’ been more apt).
First, Draghi confirmed that the ECB would launch a 60-billion-euro-per-month ($69 billion) QE program on March 1. The initial program will run through to at least September 2016 meaning that it will ultimately total around 1.1 trillion euros. More significantly, though, he also inferred that it would mutate into open-ended QE if this first round failed to deliver the required results.
Second, he announced that the ownership of the ‘distressed’ bonds being purchased will be split between the ECB and each member-country’s national central bank. This rather simplistic ideal is an attempt to force some of the risk down onto the individual countries that make up the euro zone in the hopes of spurring national governments (especially those in the spendthrift countries of southern Europe) to take their share of the stimulus efforts and to rein in the profligacy. Some hope. Alice in Wonderland springs to mind.
Having already witnessed the effects of Quantitative Easing both in the USA and the UK the markets, predictably, reacted positively. However, we’ve been down this road before and so we have a good understanding of how it will now play out.
QE gives an artificial boost to real asset values (eg. in equities and property) and creates a bubble in those market’s valuations. In the longer term, however, QE is counter-productive; eventually there is a price to be paid and those bubbles will inevitably deflate (unless QE becomes an open-ended and endless program). The trick will be to anticipate that point of deflation and consolidate profits before they dwindle.
To put it rather more crudely, QE is like giving a drunk man a gift of £10 in the hope that he’ll use it to get a taxi safely home; in your heart of hearts, though, you know exactly what he’s actually going to do with it, you just don’t know which wall he’s going to use. Likewise with governments and their fellow-travellers, the banks.
The real problem, as we see it, is that the economy of the Eurozone is stagnant and veering towards moribund. Printing trillions of euros will treat the symptoms and, for a short period, paper over the cracks, but ultimately it won’t cure the disease. The Eurozone is over regulated, overburdened with bureaucracy and over-taxed. Unless those three economically hobbling issues are properly addressed and corrected then the Eurozone will slide to its economic demise.
Equally damaging is that Eurozone banks are still not lending anywhere close to enough to creditworthy companies and individuals and are therefore stifling economic activity and expansion. Despite the trillions of euros now being printed and pumped into the Eurozone a continuation of this failure to lend will effectively strangle economic renaissance at birth.
The signal of a return to economic reality will be the next increase in interest rates. Global leadership for that will come, as ever, from the USA. It is possible that the Federal Reserve will make that decision to raise rates at its next meeting on April 29 and we have that event strongly on our watch-list.
Having started 2015 at a reading of 6566, the FTSE 100 closed the month of January at 6749, up + 2.79% for the year to date. By comparison the Quotidian Fund finished January at + 5.55% for the month and, consequently, also for 2015 to date. Our investment performance therefore continues to remain well ahead of the market.
Whilst this is very cheering news it would be remiss of me not to emphasize the rather obvious fact that a 5.55% profit in one month is not normal and is certainly unlikely to be repeated on a regular basis! Whilst that level of return indeed owes much to our stock and sector selection it is also buoyed by the short-term exaggerated effect of the ECB stimulus.
To conclude with our view of the near-term future:
The expected outcome of the Greek election result saw the installation of a coalition government led by an extreme left-wing party (hand in glove, quaintly, with an extreme right wing party). This result had been entirely expected and had already been priced into global equity markets. No doubt, however, the Greek stockmarket will be subjected to a severe negative reaction.
The new Greek government is focussed on ending austerity measures in that country and, as part of that process, reneging on repayment of the substantial loans made by the ECB the keep their country afloat some two years ago. This action would threaten the fundamental fabric of the Eurozone and, indeed, the construct and continued existence of the Euro itself.
Whilst a great deal of the invective from Greece in the immediate aftermath of the election is tinged with political bluff, it does present the EU with a catch 22 situation.
If a deal is done with the Greeks in order to save the Euro it will only open the door for Spain, Italy, Portugal and any other of the Eurozone countries overburdened with debt to push for the same relaxation of Euro ‘rules’. That road would potentially lead to the collapse of the Euro.
If the EU does not arrange a deal then that might well force the Greeks out of the Euro and out of the EU. In that instance Greece would thus become the first domino to fall as the Euro dream collapses and threatens an unravelling of the EU project.
This dichotomy will severely test the resolve of the arch-Federalists who currently run the European Union. After nurturing and protecting the ‘Federal Europe project’ through the past 60 years (and marginalising democracy in order to do so) they will not lightly or easily be blown off course. On past form, no doubt a deal will be cobbled together that will allow Greece to enjoy extended financial headroom whilst continuing to remain a member of this cosy but deeply flawed EU club.
In tangible support of the current feel-good factor pervading equity markets the earnings season for 4th quarter of 2014 is now under way. Excluding the energy sector the figures released so far show that corporate earnings in the USA are reasonably good and are mainly above expectations. There are signs, though, that the increasing and sustained strength of the US Dollar over the past 12 months is having a negative effect on the export sales and profitability of some American industrial manufacturers.
Having said that, the latest results from Apple (a company that seems to attract a great deal of misplaced criticism) released in the last week of January were exceptional. In the last quarter of 2014 they produced profits of $18 billion on substantially increased sales. That is the largest quarterly profit figure ever produced by any company, anywhere.
As indicated earlier, at some point in the not too distant future the Federal Reserve will have no choice but to allow interest rates to begin rising to more historically ‘normal’ levels.
Rates must rise because price inflation is beginning to eat away at the consumer’s ability to pay and that situation will begin to diminish consumer confidence. Demand will therefore begin to fall which will cause the supply side of the economy to become subdued. The resultant downward pressure on corporate profits will affect stock-market valuations and equity prices will fall.
Most pertinently the Federal Reserve must raise rates because, if it does not, bond investors around the world will simply dump their bonds and thus effectively force interest rates to go higher. There is anecdotal evidence to show that bond investors are already disgruntled in the extreme at lending money to governments at the pitiful returns currently on offer.
An old City cliché asserts that “Gentlemen Prefer Bonds”. After nearly 20 years of governmental greed and profligacy the days of borrow (cheaply) and spend (excessively) may be coming to an abrupt end. Gilts investors are understandably peeved at being asked to continue to finance sovereign overspending with what has long become reward free risk.
We are wary of chasing any wildly overextended one-way market moves based on central bank promises that could be rescinded at a moment’s notice. One can predict with reasonable confidence that the Euro will continue to decline in value against the US Dollar and Sterling (and the Swiss Franc).
That will limit the attractiveness of Eurozone equities to us even though their valuations will undoubtedly benefit from the ‘bubble’ effect mentioned above. The cost of hedging the currency risk is likely to outweigh the gain in equity values.
Instead we will continue to focus on individual stocks and sectors that offer distinct value. This is a strategy that is more likely to be effective in an artificially inflated market.
In other words, it was largely thanks to China that Apple reported the largest profit in its history. The most important thing to take from that statistic is that this past quarter marked the first time ever that Apple has risen to the number 1 spot in China’s smartphone market. I can’t overemphasize just how important it is to be number 1 in China.
For years Apple has failed to reach that position and at one point it had dropped down to sixth place for market share – behind Huawei, Lenovo, Samsung, Xiaomi and Yulong. The simple reason was that the Chinese wanted larger screens and with the latest iteration of the i-phone they now have exactly that.
It turned out to be the one spark that has caused sales in China to mushroom upwards and take profit figures with them.
It will also be the key to unlocking even bigger sales in the coming quarters. With an estimated 1.2 billion mobile phones in China, Apple has to date barely scratched the surface of the Chinese smartphone market.
In wider economic news, at a meeting of finance ministers and central bankers from the Group of 20 nations they essentially endorsed the use of currency depreciation as a tool to spark economic growth. That decision will no doubt create more market volatility similar to what we saw after the Swiss National Bank’s actions last month.
On a positive theme, the latest US employment and payrolls report was released on 6th February and was indeed a positive surprise. It showed that the number of new non-farm jobs created in the previous month was a higher than expected figure of 257,000 and that the US unemployment rate continues to fall.
Even better news for US consumers, though, was hidden in the detail of the report and this was the marked increase in take-home pay for the average American. Higher take-home pay equals higher discretionary income which, in turn, equals strong consumer spending thus keeping the US economy on an upward trajectory.
These statistics were mirrored in the UK when exactly the same message emerged from employment and income data released here on 18th February.
On the geo-political front markets have been buoyed in the short-term by the relatively good news from Ukraine/Russia but I believe that the new cease-fire agreement is likely to only be temporary (just like the previous one agreed in Minsk last September).
Mr. Putin constantly shifts between diplomatic and military options depending on which he believes will give Russia the greatest tactical advantage at any given time. He is running rings around the Western leaders; whilst he’s been content to use diplomacy, he has never once taken the military option off the table. The latest Ukrainian cease-fire is little more than one more tactical victory in a well-planned, protracted chess match against the West. We have yet to see the end game.
The FTSE reached its highest level for 15 years on 17th February when it closed at 6989.13. Its all-time record closing point of 6930.2 was achieved on the last working day of 1999 and it is a salutary fact that it has taken so long to re-attain this peak.
This puts into clear focus the travails that have adversely affected global stockmarkets generally and the UK market in particular for much of this century to date. The bursting of the dot-com bubble followed by the long and harrowing global financial depression took a severe toll on equity markets. Economic indicators, led by the USA, suggest that a viable recovery is under way. Needless to say, it will not be one-way traffic and market volatility will continue to create short-term concerns.
At 28th February the FTSE 100 closed at +5.80% for this year to date. By comparison the Quotidian Fund finished February at +12.35% for 2015 to date.
Markets remain volatile; already in this first quarter the S&P 500 Index has risen or fallen over 1 percent intraday on 17 occasions. By contrast, during 2014 the stock market moved 1 percent or more on only 10 days per quarter.
Every good report on the economy is met by speculation of an imminent move by the Federal Reserve to increase interest rates in the United States. Any hint of a rate increase sends shudders through the markets and propels equities downwards.
Adding fuel to this speculation, the latest US employment report was released on 7th March and was another humdinger. The American economy created 295,000 jobs in February, a figure far above the average prediction for a rise of 235,000. That February number was also up sharply from 239,000 in January.
The unemployment rate sank to 5.5 percent from 5.7 percent and is now at its lowest level since May 2008.
In the immediate aftermath of the release, US gilt yields spiked higher across the board. Conversely, equities were marked quite substantially down on widespread concerns that the Federal Reserve would be prompted to increase interest rates sooner rather than later.
There is no shortage of tricky cross currents for investment managers to navigate at the moment. In our view the best strategy in this situation is to review the portfolio and ensure that we stick with highly-rated stocks in economically beneficial sectors whilst avoiding those vulnerable to interest rate shocks.
The other main influence this month was the latest Federal Reserve meeting on 19th March. The Fed’s dilemma at that meeting was that it has clearly been hitting the target on the growth side of its mandate but it has equally clearly been missing the goal on the inflation side of its mandate. The problem it therefore has to resolve is when to raise interest rates. That situation is further complicated by the recent strength of the dollar which now threatens to dampen additional progress in the US economy. An untimely increase in US interest rates would promote even greater unwanted strength in their currency.
US economic growth is still noteworthy and their job market is in good shape although housing remains in the doldrums. The Fed also dropped its pledge to be “patient” about raising interest rates, a move that opens the door to a rate increase in the foreseeable future.
But the most important thing is that the Fed made a number of veiled hints in relation to the dollar and the side effects of its recent remarkable strength. Specifically, their statement noted that “export growth has weakened”; that “inflation has declined further below the Committee’s longer-run objective” and that the “Committee continues to monitor inflation developments closely.”
In her post-meeting press conference Fed Chairman Janet Yellen commented further on the dollar. She said “we are taking into account international developments” in currencies, and cited the “depressing influence” of the dollar’s rise on inflation as well as exports.
No doubt this is the Fed’s attempt to prepare the market for returning to historically more normal interest rates (because of improved economic and job growth) but simultaneously talk the dollar down (to prevent imported deflation).
Our view currently is that US interest rates are unlikely to increase before June at the earliest and, although it is not a fashionable opinion, that rates may stay on hold for some time beyond that for fear of causing a decline in corporate profits. If we are proved to be wrong then we will, of course, change our opinion.
On 20th March the FTSE reached its highest ever level of 7024 before settling back marginally to close at 7022. Its previous all-time record closing point of 6930.20 was achieved on the last working day of 1999 and it is a salutary fact that it has taken so long to re-attain and exceed this peak. The challenge now will be to sustain this 7000 level, although by the end of March the FTSE had slipped back to a reading of 6773.
Economic indicators, led by the USA, continue to suggest that a viable recovery is under way. However, the global glut of cheap money and its resulting consequence of creating an ever strengthening US dollar is beginning to have a negative effect on American corporate earnings and profitability. If this dollar strength is allowed to continue unchecked then it will result in falling equity valuations. We remain vigilant.
At 31th March the FTSE 100 closed at +3.15% for 2015 to date. By comparison the Quotidian Fund finished March at +13.63% for the same period.
It is fair to say that Quotidian’s performance over the past three years has been excellent and in the first quarter of 2015 it has been exceptional. Of course, it is the intrinsic nature of stockmarkets to see a period of correction after such a prolonged bullish phase and it is therefore unlikely that our pace of growth since 1st January will be sustained throughout the year. We do, though, have a sizeable cushion against the effect of any potential market adjustment.
Having said that, our mandate is global and our strategy is to try to be in the right market sectors and the right companies in those sectors at the right time. Our analysis therefore focusses on finding companies that have:
a long enough history for us to opine with confidence on their financial stability
a long history of share-price reliability and relatively low volatility
a strong focus on research and development in their specialist areasWe will maintain that approach and our vigilance as we seek to navigate the rest of the year.
First quarter earnings reports were in full swing during April and became the main economic focus of the markets.
The banking sector generally benefitted from stronger capital markets which led them to better than expected earnings and profits.
Lower oil prices and a strong US dollar were cited as the proximate causes of some disappointing numbers in those industries relying on the manufacture of consumer products.
Healthcare, however, remains a promising sector to invest in for stability and growth potential.
In aggregate, S&P 500 profit estimates for the quarter have fallen 8 percent since January 1st. This is the largest decline in earnings expectations since the financial crisis in early 2009
At this rate, S&P 500 earnings are expected to drop nearly 5 percent year-on-year, the first outright decline in quarterly profit growth for American blue-chip stocks since 2012.
So far 85 companies in the S&P 500 have announced negative earnings while just 16 have guided estimates higher. Perhaps more troubling still, top-line sales growth is forecast to fall 3 percent this quarter, putting profit margins under pressure.
But some of the best performing sectors so far this year are still expected to post year-on-year profit growth and we have highlighted Healthcare (with expected profit growth of 10.7 percent) beating all other sectors.
On 29th April the usual official government numbers were released and confirmed that US Gross Domestic Product grew by just 0.2 percent in the 1st quarter. That was much worse than the 1 percent forecast of many respected economists and less than one-tenth the 2.2 percent growth rate in last year’s fourth quarter. Very disappointing.
US exports also declined at a 7.2 percent rate courtesy of the strong dollar. In addition, core inflation slowed to a 0.9 percent annualized rate – the lowest rate in more than four years.
Those figures confirm that, as we’ve stated in earlier reports this year, most of the US first quarter economic woes were caused by two factors: falling energy prices and an unfeasibly strong dollar.
One bright spot in the economic releases was the US Employment report which showed that jobs numbers were much better than expected; in fact they were the best employment figures seen for 15 years and a source of some welcome optimism.
Those factors tend to support our earlier assertion that the Federal Reserve is more likely now to delay the start of gentle interest rate increases until later this year.
Indeed, the strategic message from the Federal Reserve was basically unchanged with the slowdown in US growth attributed to “transitory factors.”
The last week of April was relentlessly negative in global stockmarkets, and particularly those in the USA and the UK. We viewed those declines in both jurisdictions as synthetic. In particular, the last trading day of the month saw our equity holdings marked down by 2.50% across the board; a highly unlikely scenario if this was based on genuine economic factors.
Our stance was supported by the fact that, as I write this report, the first trading day of May has seen all those holdings marked up again, strangely, by 2.50%!
On 30th April the FTSE 100 closed at +6.01% for 2015 to date. By comparison the Quotidian Fund finished March at +14.01% for the same period.
The UK faces a General Election on 7th May and the local market is no doubt positioning itself in the event of an unhelpful result. Opinion polls are notoriously unreliable and, if taken too seriously, can lead to inaccurate conclusions. We believe it is prudent not to act prematurely upon a speculative view of the outcome but to wait until the conclusion is clear. Naturally we will take whatever action we deem to be appropriate as soon as we see the factual evidence.
By the end of April 356 companies in the USA (representing 80 percent of the S&P 500 by market capital weighting) had posted first-quarter results. Aggregate profits were better than analyst’s forecasts and so provide a reason for guarded optimism.
Fast-paced profit growth, especially in biotech, keeps pushing health care stocks higher (up 24 percent over the past 12 months) and they lead the field in performance so far this year too, up 5.4 percent.
This is further evidence to support our belief in the importance of being selective and focussing on the stocks and market sectors that are delivering the best results and superior performance.
With the UK General Election now out of the way (and having delivered a market-positive result), concerns have now returned to the issue of sovereign debt generally and Greece in particular.
Greece is now at its tipping point. Its government is desperately trying to stave off default on a 750 million euro repayment to the International Monetary Fund.
Whether or not Greece gets short-term concessions will not really matter because in June it faces another 2.6 billion euro repayment and by July and August it will be required to make a further 8.7 billion euro repayment, 7 billion of which is owed to the European Central Bank.
There is simply no way Greece can pay off that debt; it just does not have the money. Merely in order to make a minor 200 million euro payment early in May the Greek government had to call in all excess cash from its regional banks.
Nor can Greece rollover the debt without paying excessive interest rates and thus bankrupting the country even further.
Greece itself is not solely to blame for this crisis. Yes, it has its black market economy and a grossly inefficient system of tax collection but, sadly, in 2001 Greece was effectively forced to join the euro through dubious financial manipulation devised and sponsored by a foreign investment bank.
It is therefore no surprise that it is now having trouble repaying that debt.
The wider issue is that it’s not just Greece that is about to reach the tipping point. Many other European countries are struggling under the burden of worrying levels of sovereign debt.
Whilst Greece is certainly the worst, Italy isn’t far behind and nor is Portugal.
Greece’s sovereign debt is equivalent to 175% of its Gross Domestic Product (GDP). Italy and Portugal are both indebted to the tune of 130% of GDP. Ireland, Cyprus and Belgium all carry debt in excess of 100% of GDP whilst France and Spain are burdened at a level just short of 100%.
If push came to shove not one of these countries is capable of servicing its debt, not even France.
Europe’s sovereign debt crisis is merely the starting point. This crisis is not confined to Europe and one of the most important aspects of the debt crisis as it unfolds over the next few years will be how it impacts the financial markets.
In our opinion government bond markets are fraught with risk and are heading towards the abyss. In recent years we have often described Gilts/Bonds as reward free risk and our view has not changed.
However, surprisingly and perhaps perversely, the history of sovereign debt crises indicates that stock markets perform exceptionally well when the public sector, not the private sector, is going bust.
Despite all its detractors and its domestic economic problems, in our view the US stock markets currently represent the safest, deepest and most liquid bastion of capitalism in the world. Quite simply, from a financial perspective the USA’s biggest companies will outlast its government.
On 31st May the FTSE 100 closed at +6.37% for 2015 to date. By comparison the Quotidian Fund at the end of May was +21.69% for the same period.
That is a quite remarkable achievement at this stage of 2015 and positively reflects the strength of our focussed approach to stock selection based on our strategy of aiming to be in the right sectors of the right markets at the right time.We are obviously aware, though, that markets can make one look very foolish very quickly and so we remain dedicated to the task at hand with the intention of maintaining our pre-eminence over the market index.
The long-running and somewhat tedious game of poker being played between the Greek government and the financial leaders of the EU dominated market sentiment throughout the month of June and became the proximate cause of equity market volatility towards the end of the month.
The fact that the EU continued to supply substantial liquidity to Greek banks (not just once but on three occasions) in the last week of the month does indicate far more about the likely denouement of this ‘crisis’ than the meanderings of various political leaders.
In our view, the timing of interest rates by the Federal Reserve in the USA has a much more significant effect of the direction of stock-markets over the next year or two. Following the Federal Reserve policy meeting in June we heard confirmation from Janet Yellen that the pace of rate increases would be slow and measured, unlike the mechanical, robotic increases we were familiar with when Greenspan (the man whose financial stewardship of the US economy, in our opinion, caused the financial depression of 2007-2012) was at the helm.
In light of that, stock-market investors may have less to fear from higher rates than has currently been priced in.
Whilst the focus of the market was diverted by these two issues it is easy to overlook a large number of positives:
- S. tax receipts were up 0.3% year-over-year in May which is remarkable given just 3.0% nominal GDP growth.
- Despite the problems with Greece, the ECB’s balance sheet increased by 12 billion euros last week and is scheduled to continue to increase at least for the next year. This is part of the expanding global stimulus.
- Key US data is all trending upwards:
- Construction spending is up
- Vehicle production is up
- Vehicle sales are up
- Trade is up
- Unemployment claims are down
- House prices are up
- Small business confidence is higher
- Employment is improving
- Hourly earnings are improving and the number of U.S. job openings has finally surpassed the previous peak set in 2001.
- Mortgage applications in the USA increased by 9.7% week-over-week.
- Many countries are taking measures to spur growth
Evidence of economic growth continues to present itself and provides cause for optimism as a counter balance to the prevailing doom and gloom.
Of course a stock-market pullback is inevitable at some point but we believe that the concerns over Greece have now been overdone.
Generally, a market correction is defined as a decline of 10% or more. That hasn’t happened to the S&P 500 Index since 2011, although the index came close in the summer of 2012 (-9.9%).
We have had a number of pullbacks in the range -5% to -7% or so but it has been over 150 trading days since the S&P last declined by 5% or more, and more than 900 days have passed since the last 10% correction.
Our analysis indicates, though, that it usually takes no more than 56 trading days for the markets to recover from a 10% correction.
On 30th June the FTSE 100 closed at 6520.98 (which is –0.69% for 2015 to date). This represented a decline of 6.64% in the month of June.
By comparison the Quotidian Fund at the end of June was +20.79% for the same period….being a fall of just 0.74% in June.We remain focused on protecting our gains whilst seeking opportunities to benefit from this period of volatility.
Mainland China’s Shanghai Index had moved substantially higher in just the 12 month period up to June 2015. An extraordinary gain of 150% was largely made possible by a massive expansion in margin lending, most of it off-the-books (where brokerage accounts can be leveraged up 5-to-1 or more). This, combined with the Chinese penchant for risk-taking (some might call it gambling), led to very considerable over-valuation in many stocks and, of course, of the market itself.
However, and not before time, officials in Beijing finally recognised that stocks were getting overheated and they decided to crack down on margin trading. Since then, shares on the Shanghai stock exchange have plunged about 30%. The China stock market meltdown has accelerated in spite of Beijing reversing course and pulling out all the stops early in July in an attempt to support plummeting share prices.
In the UK, for the past six months many commentators have been predicting a market correction and, given the market’s propensity to allow sentiment to overcome economic reasoning, these predictions often become self-fulfilling. From its peak above 7100 in April the FTSE index had declined to 6400 by 8th July…..a fall of 10% which represents the usual definition of a correction. With their attention drawn to events in Greece and in China, the media do not yet seem to have grasped that fact.
Our historical analysis indicates, though, that it normally takes no more than 56 trading days for markets to recover from a 10% correction. That being so, we have taken short-term advantage of what we see as an oversold UK market.
In America, the Federal Reserve has continued to lay the groundwork for increasing interest rates. The Fed chairman, Janet Yellen, suggested in her July post-meeting summary that the first increase in interest rates would likely come in September. As ever, a few days later a similar announcement was made here in relation to UK interest rates. Unlike the apparent delight in obfuscation and the delivery of surprises which was the hallmark of previous Federal Reserve regimes, this increase (when it comes) has been so well signalled that it shouldn’t cause a real or lasting problem to stock-markets.
Finally, the second quarter earnings reporting season is upon us and is bound to be full of surprises in the weeks ahead. Largely as a consequence of a strong US dollar in the early part of this year it will be a close call on whether or not we see much growth in US corporate profits overall. With that in mind we continue to be ultra-selective in the assets we choose to form the current Quotidian portfolio. Our aim remains to seek the optimum balance between risk management and the achievement of above average investment returns.
On 31st July the FTSE 100 closed at 6696 (which equates to +1.98% for 2015 to date). It represents an increase of 2.69% in the month of July.
By comparison the Quotidian Fund at the end of July was +24.69% for the same period….being an increase of just over 4.00% in July.
In the third week of July alone the FTSE100 dropped by 3% following a negative report from China in respect of that country’s manufacturing output. These numbers caused global commodity prices to decline even further and, as the main UK market index is heavily biased towards energy stocks, miners and metals it took the brunt of the decline.
However, figures from China are notoriously unreliable. In the previous week a set of very encouraging GDP numbers from that country had created a positive reaction in the FTSE100. As ever, the market over-reacts positively to one piece of good news and then over-compensates in the opposite direction to one piece of negative data. And all this from figures that are historically unreliable and will in due course, no doubt, be quietly adjusted.
As stated earlier, we have taken advantage of what we interpret as an oversold market in the UK. If we prove to be wrong in that assessment then we will change our view and our investment positions.
In the US market the overall price/earnings ratio is currently above average at x18.5 but it’s still a long way off the pre-crash P/E ratio of x29. In our view, for the moment there is still profit to be made in equities generally and US equities in particular.
The Quotidian Fund is currently in a position of considerable strength and we remain focused on protecting our gains whilst seeking opportunities to benefit from this period of volatility.
So much for the lazy, hazy days of summer. As you will have seen, extreme volatility and fear bordering on panic returned to haunt global stock-markets from mid-month onwards and kept us glued to our screens.
Rather than rehearse much of the detail with which you will already be familiar, let me precis the salient points which led to stock-market conditions last seen at the height of the global financial depression in 2009-2010.
On Tuesday 11th August China wrong-footed financial markets by suddenly devaluing its currency, the yuan, by nearly 2%. That may not sound like a lot but it was their biggest downward currency move in two decades.
Superficially, China’s motivation for doing this was to make their exports more competitive in foreign markets and, on the other side of that same coin, to make imports into China more expensive.
This move caught equity markets completely off-guard and was interpreted as a desperate attempt to jump-start China’s sagging economic growth. Currency markets immediately marked the yuan down by yet another 2%. According to market analysts, though, it would take a much larger depreciation in the yuan to significantly boost exports. It is estimated that a 10% drop in the currency’s value would be needed to fully restore China’s export growth.
At a more profound level, this devaluation was in keeping with Beijing’s long-term goal of opening up its financial markets and being more flexible with exchange rates. The US and the International Monetary Fund have insisted on this more open approach as a prerequisite for the yuan to be more widely used in global commerce.
The risk in the move they have made is that a sliding Chinese currency could trigger massive money flows out of China in exactly the same way as we’ve seen with capital flight from other troubled parts of the world over the past two years. Of course, this would then deal another blow to China’s already struggling stock-market.
Whilst one might view the actions in Beijing as being entirely self-interested and self-serving it is difficult to be too critical or proscriptive. China has simply followed a well-travelled road. Quantitative easing, currency manipulation and protectionism have been hallmarks of US policy for many years and indeed of the UK and major European countries too. Likewise, China’s neighbours and biggest trading partners (Taiwan, South Korea, Malaysia, Singapore and others) have for years been depreciating their own currencies at China’s expense.
It may be over-generous but it is tempting to interpret Beijing’s actions as being more naïve than devious as the old guard gives way to the new and China slowly mutates from a command-controlled communist style economy towards a more capitalist free-enterprise system.
According to Bloomberg, dollar borrowing in China has expanded five-fold since 2008 as Chinese companies and also individual equity investors have taken on billions in dollar and euro denominated debt in order to leverage their investments. The costs of servicing that debt were substantially increased by the yuan devaluation and this is likely to have contributed to the stock-market sell-off which began on 12th August and continued to then escalate around the world.
Factors which exacerbated the gyrations and general decline in equity prices include the forced exit of investors from over-leveraged positions, computer-based trading, low trading volumes and therefore low market liquidity, market makers cynically widening spreads and emotional investors being dislocated.
The financial media is not blameless. Too often they seem to prefer to manufacture ‘crises’ and then fan the flames of fear by using extremely emotive language to ultimately generate panic. Good news does not sell newspapers nor television advertising space. Sadly, creating and promoting bad news is a self-fulfilling process that helps only to exacerbate ugly days in the market
The breadth, depth and speed of intraday market action over 10 consecutive trading days was extraordinary. Ten successive days of relentless downward pricing culminated in a very steep markdown on 24th August by which time all major equity markets had fallen beyond the level usually accepted as being a correction. Even the razor-sharp minds and professional Cassandras inhabiting much of the fourth estate have cottoned on to the fact that their long-touted and heralded global market correction has now actually taken place.
On 31st August the FTSE 100 closed at 6248 (which equates to -4.85% for 2015 to date). This represents a decline of 6.70% in the month of August.
By comparison the Quotidian Fund at the end of August was +14.82% for the year to date….being a decline of 7.82% in August. Despite the downward revaluation in the month, we remain strongly in positive territory for 2015 and 19.67% ahead of the FTSE100 index.
As long term readers will already know, our research indicates that it normally takes no longer than 54 trading days for markets to regain the ground temporarily yielded through a market correction.
To further support this assertion the CBOE Volatility Index (VIX) is an objective measure of stock market fear. On 20 August, volatility as measured by the VIX index was still well below several of the panic-striken peaks seen in previous crises. However, the extreme VIX frenzy on 24th August (at one stage it spiked to a reading of 90) was the highest recorded in the past six years. Historically, over the past 30 years whenever the VIX has spiked sharply higher (and above a reading of 50) it has almost always been at, or very near, a stock market bottom.
We believe this to be a reliable signal that stocks are grossly oversold and we expect a strong rally in the weeks and months ahead (although, no doubt, there will be further bumps along the way).The most important economic and potentially market-moving news in September will be the Federal Reserve’s decision on US interest rates at their mid-month meeting. They have signalled their intention to increase rates for the first time since 2006 and it will now be very interesting to see the effect of August’s extreme stock-market volatility on the Fed’s decision making process and timing.
Italy is facing its greatest financial crisis in the post-war era. The country’s banking system is bankrupt and no one in Europe seems willing (or able) to fix it. Since 2009 Italian bad debts have multiplied from less than 3% of total loans to more than 18% today. As a result, many Italian banks have far more bad debts than they have capital to back them up.
To put that into better focus, banking regulators generally begin to worry when banks’ non-performing loans reach 5% of the bank’s assets. In Spain, for example, during the height of their housing bubble burst in 2010 (when the whole country appeared bankrupt) non-performing loans never went much above 10%.
In Italy today the total value of non-performing loans is an unprecedented 18% of assets. Italy now has the biggest concentration of weak large banks in the world; nine institutions in all. Moreover, five of Italy’s nine weakest global banks are megabanks, each with over $100 billion in assets:
- Unione di Banche Italiane, with $132.8 billion in assets;
- Banco Popolare SC, with $139 billion;
- Banca Monte del Paschi di Siena (the oldest bank in the world), with $197.6 billion;
- Intesa Sanpaolo, with $796.9 billion; and
- the largest of all, UniCredit SpA, with over $1 trillion.
There is, however, one very nasty glitch to this ‘simple’ plan. In Italy, the bonds of these banks are not owned by institutions but by very many small retail investors. According to Bank of America Merrill Lynch, small investors own 235.6 billion euros of bank bonds and the banks do not want to panic them (with all the civil unrest and social deprivation that would bring in its wake).
To make matters worse, Italy also has more public debt than any other EU member except Greece whilst having an economy that is nine times larger than that of Greece. In a full-blown banking crisis, not only would Rome be hard pressed to come to the rescue but Brussels and the EU would have a tough time saving Rome.
So we find ourselves in a standoff. German Chancellor Angela Merkel (and even the Italian-born head of the European Central Bank, Mario Draghi) refuse to budge on this issue and will not bail out the Italian retail bondholders. Italy’s technocratic Prime Minister Matteo Renzi (put in place by the EU itself) is desperately trying to reason with them but, thus far, the talks are at a standstill. If Italy is forced to do a “bail-in” (which is banker’s terminology for bankrupting the bondholders) then the political and social backlash could tear Europe apart.
Italy already faces a very strong independence movement in the Five Star party and it has been winning local elections at a rampant rate. If Merkel and Draghi force Renzi to effectively wipe out 15% of the country’s wealth as a result of bank recapitalization then the backlash will be huge.
Italy is the third-largest economy in the Eurozone and if it goes then the eurozone will probably crumble soon thereafter. If the all the parties concerned can’t come to a practical agreement soon then the situation will go from bad to worse. The euro will come under increasing pressure and the political crisis in Italy along with the collapse of their banking system will most probably result in Italy leaving the EU. The EU will then collapse.
The EU project in its current form and with its deliberately anti-democratic aim of creating a Federal Europe will ultimately be a failure of epic proportion and we predict its demise by 2021. Perhaps then (if not before) we can return to the original concept of a pan-European free trade area without all the federal baggage. For those who still harbour lingering doubts about the very positive benefits of Brexit, the Italian crisis and its likely denouement would strongly suggest that the UK has dodged a bullet.