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Quotidian Investments Monthly Commentary – December 2018

January 3, 2019

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.

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