Quotidian Investments Monthly Commentary – October 2018
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.