Quotidian Investments Monthly Commentary – November 2018
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.