Ursus Arctos Horribilis. Our non- Latin speaking reader base might know this as the common Grizzly bear.
OhShiznit ItsHitTheFan Horribilis. Now to Wall Street that’s National Geographic speak for the obvious.
Yes bear sightings were indeed de rigueur at the start of 2016. By the 21st of January at least 40 stock markets around world were in bear territory (classically defined as a 20% or more drop from peak prices – for most markets this would have been the earlier part of 2015). Canada, much of South America and the Middle East, a significant portion of Europe, Russia, China, Japan and Indonesia were mauled.
Bulls however, somehow managed a late month charge and here’s how we finished. The MSCI All World Index went down 3.59%, with the US and Europe falling 3.7% and 6.3% respectively. Asia unfortunately bore a bigger beat down than most, caving in nearly 9% for the month. A quick scan of Latin American ETFs revealed a surprising fightback against the general dour sentiment, dipping an average of just 1%. Could this be a possible value play in the making?
And what of oil? Another low? You guessed it! Small mention of course must go to the littlest of bull runs that oil put on, surging 26% from that bottom to finish the month at a whopping….drum roll please…USD 33/barrel. That’s still lower than last month’s price and a very long way from the USD 100+/barrel realm that the world got intoxicated on. Math unfortunately, is unnecessarily exciting when you are working with a small denominator.
When bears start to come out of hibernation, a certain element predictably, starts to shine alongside. Investors rushed to their favorite safe haven as gold became 2016’s best performing commodity (to date) and precious metals overall benefited from the market stress.
Locally the ASX took a 5% hit in January, with successive closes below the 5000 point mark giving a possible sense that the domestic share market might unfortunately be getting too familiar with this territory. Beneath the headline negative return however, there was a clear case of sector rotation (into safety plays) by investors, as the consumer staples and utilities sectors managed to get just above water. Energy and financials under-performed the overall market while materials and resources were the main drags on indices. After a promising three month recovery, CBA was struck down for 8%. BHP meanwhile put in a 10 year low and is now off an eye-popping 67% off its peak share price in 2011. The Aussie dollar, a usual victim of risk-off moods, took another rollercoaster roundtrip to the 60’s (68 cents to be exact) before displaying some more resilience to finish the month just under 71 cents.
It was a challenging start at Private Wealth no doubt. While our bond allocations performed as they would during times of equity turmoil, it was unfortunately not enough to counter the under-performance across our Aussie small/mid cap, Asian and international exposures. Classic investing theory will subscribe to the fact that in times of broad market stress, higher risk investments (i.e. small/mid cap & global stocks) will typically be the first to see a dash to the exits. This time was no different. The bright spot amongst this turmoil was gratifyingly the performance of our (equity) long/short investment manager coming out on even keel and to which a fair few of our growth oriented clients have exposure to. While it’s easy to get carried away by near term numbers and volatility, we have in fact been positioning client portfolios to withstand such disruption for some time. And from a longer term point of view, one month’s returns (or lack off) does not maketh a year’s and we remain comfortable with our positioning.
Maybe the more appropriate question might be “WHY NOW?” So here’s a few possible answers.
1) An oil price driven panic - Where oil goes, equities seem to be slipping close behind in its slick. The correlation between oil and the US share market is now up past 80% and well above its twenty year 25% average! We don’t need to tell you how big and far reaching (into all parts of life) the energy market is. The threat of deflation from the low cost of oil, the possibility of sovereign defaults amongst nations that rely on oil revenues for their coffers, the relentless stress in the high yield (junk) bond market , the growing list of (energy related) corporate defaults and ensuing job losses. These are just some of the concerns weighing on investors’ minds.
2) The divergence between high yield credit and equities – when the economy and credit markets are improving, high yield bonds perform well as investors are more inclined to risk taking. Both also underperform when the economy is slumping. A clear correlation thus exists. It has often been said that equity prices cannot rally long without the support of high yield credit markets. Stock buybacks and financial engineering don’t magically finance themselves! With credit spreads blowing out in the last few months (and investors rotating from high yield to investment grade), and as the chart below demonstrates (to the end of 2015), were stocks simply catching up to deteriorating high yield credit markets?
3) Are equities simply undergoing a healthy and necessary re-valuation after an unprecedented, cheap credit fueled, multi-year surge culminating in blow out valuations? A world of flagging demand, very low (if any) inflation and wage growth, a commodities/resource downturn and uncertainty around negative rates are hurting corporate earnings. A persistently high USD in 2015 wouldn’t have helped US companies who can now lay claim to 60% of their profits originating offshore. A disappointing start to the US earnings season and the stresses facing European banks thanks to zero/negative rates pounding their margins (putting them on the path to a slow demise or forcing massive re-structures and lay-offs) have so far taken its toll in 2016. What this also means on the flipside, is that equity valuations are starting to look more attractive than they have in a while! And especially for companies with healthier balance sheets and business models.
All this talk of ferocious, furry mammals might leave one feeling beary (sorry couldn’t resist) nervous. This is where the distinction between a bear market and a “bust” must be drawn.
Isaac Newton would have probably made a good money manager had he not been too obsessed with that apple falling on his head. Down markets are just as much a part of investing as up markets, just as how cycles permeate finance, economics and life in general. In fact, since around the 30s we’ve had just as many bear markets as we’ve had bull runs – eight. What is more important- for the longer term investor- is how these markets/cycles are navigated, where assets are allocated in both these instances and where one chooses to sit in the risk continuum during each of these phases. The strict focus on safety, preservation of capital and quality assets (with strong financials and stellar management) should continue to guide investors in the toughest as well as the best of times. Opportunities abound on the back of both beasts if you take the time to be friends with both.