After a long bull run in global stock markets, recent movements have unsettled many investors and have led to questions on whether stock markets are even able to head higher going forward, or whether the cycle has had its day.
Robert Hardy, Head of Intermediary Sales at Seven Investment Management (7IM), sat down with Ian Jensen-Humphreys, 7IM’s Chief Investment Officer, to discuss this.
In this article, they talk about how the team at one of the investment managers selected by Wren Sterling to run clients’ investment portfolios is looking to manage turbulence in the markets. Ian also outlines which risks 7IM believes are important, and how current events could play out in the future.
As Ian reflects on the first quarter of 2018, he said “One of the most pertinent quotes about the market at the moment is one from Ben Graham (a mentor of Warren Buffett and widely seen as the ‘father’ of value investing). In 1949, he stated that:
‘In the short run the market is a voting machine, but in the long run it is a weighing machine’.
“When people review the recent history of markets, what they’re really focusing on is the popularity of particular stocks, sectors, or indices. The headline most recently published about that investment is present in investors’ minds, and it affects their behaviour. While harsh, Ben Graham dismisses many of these people as speculators who typically pay more money in transaction charges than they make in returns.”
“Investors, however, do recognise that they should be taking a longer term view. Investors should be evaluating and acting on analysis of the fundamental qualities of companies and markets. They should be looking to buy high-quality investments at a good price and which should, over the long term, gain in value because of the return on capital and expectations for future growth against projected scenarios. But it’s a difficult task to achieve, especially in the face of messages that short term storylines can convey.”
This is a challenge for most investors, no matter how long they have been active in the markets. How do you sift through all the information being published to determine what’s important and what isn’t? For Ian, this screening is part and parcel of the investment process that underpins the team’s portfolio decisions. It’s an approach that he believes helps the team look through the market ‘noise’ and determine what newly available information should be driving their decision-making.
“We had well over a year of calm, where markets seemed to gloss over, even ignore, any bad news – whether it was economic, financial, or political – and carry on moving steadily higher. By the time December 2017 had ticked past, media headlines almost seemed duty-bound to include the words ‘record high’ across asset classes. However, it was a situation that caused us concern. Research showed that the last time the markets had been so calm was in 1965. In 2017, we saw just 8 out of 252 trading days where the S&P 500 moved by 1 per cent or more, following the second half of 2016, which had seen just 10 such days. These levels are well below the long term average number of days when the market typically moves in a year – usually about 50. So it was always a question of when the market would begin moving up and down more frequently rather than if.”
Although the team has positioned itself to take advantage of an increasingly improving synchronised global growth, they have remained mindful of the risks and the return to a more traditional level of market movements.
“We have always taken a risk-conscious approach to managing money,” explains Ian. “The low volatility meant that ‘buy the dip’ was not an action being played out over weeks or months, but over days or even hours – as was the case when Donald J. Trump was elected U.S. President in November 2016. Complacency was king, and our experience and process highlights how often complacent markets become dangerous ones.”
Since this period though, volatility has returned. The S&P 500 index fell by nearly 10 per cent in the first week of February. This percentage drop is seen by professional investors as a ‘correction’ rather than anything more serious (a correction back to a level that makes sense). These movements are within the levels of what we would consider normal. We have not continued to see markets slide towards a 20 per cent drop that would denote a bear market, or the 30 per cent that often heralds the start of a recession – sometimes 6 to 12 months later. And while volatility has returned, so too has the markets’ focus on news.
Ian cites the example of the tech sector, which he believes demonstrates the attention that the market is now paying to headlines, and in particular how it is reacting badly to negative news.
“The technology stocks of Facebook, Apple, Amazon, Netflix, and Google (which have become known as the ‘FAANG stocks’) helped the growth the U.S. equity market over the course of 2016 and 2017. In fact, the performance of these stocks alone represented some 20 per cent of the total performance for the S&P 500 in 2017. However, the recent fallout for Facebook from the Cambridge Analytica revelations, its data gathering, and the subsequent knock-on effect on the stock price highlights how fortunes can turn.”
“There is also a longer term threat to the sector, given that governments and regulators are in the early stages of developing their interaction with these businesses. There will certainly be bumps in the road and challenges to their business models. One hurdle will definitely come as governments agree a consensus on taxation. In a world where governments are hungry for revenue to plug deficits, global corporations with ‘efficient tax optimisation’ are easy targets. One example is Amazon. I purchase a UK-manufactured product from a UK company as a UK citizen via Amazon, yet my bill is routed via a Luxembourg-domiciled entity, even if every stage of that product’s life cycle has remained on these shores. These practices make such firms an easy target for both the media and politicians, which in turn will affect their share prices.”
Aside from the technology sector, where else does Ian foresee risks?
“A trigger for market weakness is from the U.S. where a data point highlights that wage inflation could be coming through. However, we believe that inflation will remain contained over the coming year, as we believe there is still sufficient slack in the U.S. economy, which is being concealed by the low headline unemployment rate. Meanwhile, over the last quarter, the fundamentals underpinning stock markets could be seen to have improved – particularly in the U.S. as the impact of the tax reforms and deregulation are beginning to be felt by businesses.”
“However, while corporate earnings, corporate profits, and global growth are encouraging for the future, the potential for a trade tiff between China and the U.S. does pose a risk. We had apparently been on the brink of a nuclear stand-off between North Korea and the current U.S. Presidency before common sense seemed to reassert itself, leading to more measured statements, and that could even lead to progress talks. A similar scenario could easily play out between China and the U.S. if China seeks to redress issues flagged by Trump’s investigation into intellectual property.”
“But whatever other news flows through to the markets, one thing we do see continuing to play out and affect investors is volatility. We’ve been taking steps to protect our portfolios through the use of ‘put’ options, which are contracts that should deliver profits if the markets start to slide below pre-agreed levels. However, these are not universal remedies and would only smooth the path of the portfolios over time.”
“Our focus remains on the fundamentals. We are increasingly conscious of the timeline of the current economic cycle, and we realise that at some point there will be a slowdown. As such, we remain vigilant to any hints from key economic and market indicators that start to signal a potential downturn.”
This interview took place on 4 April and reflects the thinking of Seven Investment Management (7IM) at that point in time. It should not be taken as investment advice. Please speak to your adviser prior to making any investment decisions.
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