Current Market Turbulence
by Alexander Beard, on Aug 15, 2019 3:05:30 PM
The first point is that markets can operate differently to economies.
Markets can move in response to real information such as profits, dividends, acquisitions and mergers. They can also move in response to moods and predictions, which are less tangible.
In these modern, data-driven times, more of the predictions and moods can come from “technical analysis”, it’s a reassuring expression that implies solid foundations. This generally means a review of large amounts of statistics and comparisons to patterns in the numbers seen in the past. As yet, however, there is no method of predicting the future that is completely reliable, no matter how technical or analytical it is. I heard one fund manager comment wisely that in the investment business, being right about the future 51% of the time can be considered good!
One often used technical measure of the risk of a recession is to compare the yields on government bonds of different maturities. Usually the longer you tie-in the higher the yield, because investors do need some compensation for locking up their funds. You can plot this on a chart and in normal conditions it would look something like this:
When investors get nervous they tend to buy more government bonds for security, especially those that mature in the near future. This pushes up the price, and means that the fixed interest paid on each bond is effectively a smaller proportion of the price paid. Putting it another way, the yield reduces. When the yield gets lower for future maturities it can be a sign that investors are buying more cautious assets, perhaps preparing for tougher times. At the moment the yield curve is inverted, meaning that the yield gets lower as the maturity extends. The inverted yield curve looks like this:
Now this can be a reasonable predictor of recessions, but like every other indicator it is not fully reliable. It says more about the mood of investors than the economic facts. Nonetheless, markets have got a little bit spooked and we have seen a bit of a sell-off.
From the economic side, things look in reasonable health. Most of the globe is in expansion mode or recovery mode, save only two countries which are in recession (Venezuela and Argentina). [source: https://www.economy.com/dismal/tools/global-business-cycle-map 15 August 2019].
Recently, because the global economy is broadly OK, it has been political events that have driven markets up or down – Trump’s trade wars and to some extent Brexit (although mainly UK, and to some extent in the EU).
The inverted yield curve has been in that shape for a few months now, so this is not new information, admittedly it is currently a little deeper at present but not remarkably so. But it is as if the markets have only now decided to react to this information. Coupled with the UK and Germany each suffering a contraction in the economy in Q2 there is some economic news that supports the shape of the curve although none of this should come as a surprise given Brexit issues.
Meanwhile, in the US, inflation figures came in at a benign level, which will not deter the Fed from cutting interest rates again – this may well give markets another shot in the arm later in the year. If some positive economic news comes in – growth in Q3, good business results etc then we could well see a swing back up.
But some of these views are a little short-term, and we prefer to think about the year or years ahead. The further ahead you look the harder things are to predict.
There is an easy way to get your predictions right though, just by playing the odds. The simple fact is that on an annual basis stock markets rise more often than they fall, so to try and guess which year they will fall you will find the odds of being right are stacked against you. Back in 2014 there were many who saw markets as being overvalued – see this article in the FT from 2014: https://www.ft.com/content/c53f9649-0626-3c90-8d3d-3472ffdce2d7 and 2015: https://www.ft.com/content/85d0becc-58c5-11e5-a28b-50226830d644 , and 2016 CNBC / Warren Buffett https://www.cnbc.com/2016/08/04/if-you-follow-warren-buffets-strategy-this-market-is-significantly-overvalued-commentary.html etc. etc. etc.
Nobody is able to predict with accuracy how markets will progress, but we tend to find that the more time an investment is given the better the outcome, rather than waiting for the right moment to start.
With a diversified portfolio, however, it should matter less. The chart below shows the 5 year period with the credit crunch in the middle, for GBP investors. The Mixed Asset Sectors are for funds that contain a mix of bonds and shares, the more bonds (and fewer shares) the less volatile they are. I have compared the 60% shares and 80% shares sectors, against the MSCI World index over this period. The most interesting point for me, however, is that it takes around 2 years for values to fall and then recover and the speed of the upswing is similar to the downturn. Indeed, this is why we say that any risk-based investment should be considered as having a minimum 5 year term to give it a good chance of providing growth. Even in the bleakest of times this should be enough time to provide a positive return.
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