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Quotidian Investments Monthly Commentary – December 2016

January 2, 2017

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.
One year ago in December 2015, and for the first time in nearly a decade, the Federal Reserve raised US benchmark interest rates by a quarter-point.  At the end of 2015 the Federal Reserve also expected US inflation to trend higher in 2016; indeed it has, with core inflation in the USA up 2.1% year on year and accelerating over the past few months.

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.

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