Market Update – 7 December 2018

Mike Deverell, Partner & Investment Manager 

The quiet crash

As I write (the morning of 6 December) the FTSE 100 is trading at around 6,750, down around 2.5% on the day. In fact, since May when the main UK index hit almost 7,900, the FTSE is down by over 14% in price terms. Many other markets around the world are down even more.

It’s not just stock markets which have been hit. According to a study by Deutsche Bank, of the 70 different asset classes they track, 90% are down so far this year (in dollar terms). Deutsche say that’s the highest percentage ever seen in their research which goes back to 1901. This means that virtually anywhere you might have invested this year would have lost you money.

We have seen very little in the way of headlines about this ‘quiet crash’. This may partly be because it has mainly been a slow trend downwards rather than a series of sharp falls as we have seen today. It may also be because the headlines have been fixated on Brexit instead!

This has meant that some clients have been surprised to come into their review meetings recently to find that their portfolios are down over the quarter.

Markets have generally been worried about slowing economic growth around the world, at a time when central banks are dialing back monetary stimulus.

There have also been concerns about the impact of the so-called trade war. These have come to a head today after the arrest of the Chief Financial Officer of Huawei, the giant Chinese phone manufacturer, at the request of the US. This has been seen as a sign that things may be about to escalate.

Volatility = normality

At times like this we like to remind ourselves that sharp drops in stock markets are perfectly normal. They are a fact of investing which we may not like, but one we must accept will happen from time to time.

There are times when markets and indeed portfolio returns will be negative. It is our job to minimise these losses where we can, but also to make sure that when markets recover (which they always do eventually), that we can benefit.

Having gone into this year positioned quite defensively, we have been slowly adding ‘risk’ to the portfolio as markets have moved lower. For example, in September we bought a new defined returns product at a FTSE level of around 7,300.

We then topped up equities by carrying out a ‘volatility trade’ at 7,200. These two trades took our portfolios from being cautiously positioned to more of a ‘neutral’ position – taking roughly the same amount of risk as our long-term models would suggest. Risk and return are of course correlated, so we’d hope that increasing risk would add to long term returns.

We have now carried out a further volatility trade for most clients as the market hit our trigger level of 6,750. We have typically moved 3% of portfolios out of lower risk assets buying a FTSE 100 tracking fund instead.

This means we are now taking more risk than our normal long-term positioning. This may feel uncomfortable, but at times like these we like to recall one of our favourite Warren Buffett quotes: ’Be fearful when others are greedy, and greedy when others are fearful.’

We were certainly feeling fearful a year ago when many investors seemed overly bullish in our view. We now feel that markets are much better value and that, in some circumstances, investors are perhaps being too bearish.

We accept that there are plenty of risks out there and volatility could persist for some time. If markets recover, we will sell the tracker fund we have just bought, bank a gain and go back to being more cautiously positioned.