Market Update - 3 January 2019

Mike Deverell, Partner & Investment Manager 

The January sales...

Many of us like to pick up a bargain in the January sales.

As we move into 2019, it could be said that the shares of many companies are now on sale at very generous discounts!

Of course, this is a way of putting a positive spin on what has been a sharp fall in markets over the past few months. Rationally, we all know that it is better to buy shares when they are cheaper and that is what we always try to do. Psychologically, many investors find this difficult and in fact many are more likely to sell after a sharp fall than buy. This is nearly always the wrong course of action.

That said, like many investors we’re quite glad to welcome in a New Year because 2018 was a year when stockmarkets around the world fell. In fact, no major market finished the year in positive territory and some were down very sharply indeed.

Things have been particularly volatile in the past quarter. In price terms, the FTSE 100 Index dropped just over 10% in the fourth quarter. In fact, from its peak in May of 7,877, the FTSE 100 fell as low as 6,584 on 27 December, down 16.4% in price terms. It then bounced back somewhat to close the year at 6,728.

Other markets were also hit. For example, the S&P 500 in the US saw even more volatility, briefly falling into a bear market (defined as a 20% fall from its peak) on Christmas Eve before a sharp rebound saw it down “only” 14.3% from its peak of 3 October.

(Data sources: FE Analytics)

Cautiously positioned

As you may know, for some time we have been worried that stockmarkets were getting ahead of themselves and looking expensive relative to the earnings of the underlying companies.

It has also been a long time since we’ve seen a true bear market. Statistically, they tend to happen every five years or so. Whilst the FTSE 100 was briefly down 20% in early 2016 driven by falling commodity prices, other UK and global stockmarkets did not fall as far.

Globally, we’ve not had a bear market since the financial crisis. Given that was almost a decade ago, a bear market therefore could be seen as somewhat “overdue”!

For the past couple of years we have held less equity than usual given our concerns about valuations. We never try to predict the future but we’ll tend to hold less in an asset class that looks expensive and more in those that look better value on a risk adjusted basis.

Our issue was that it was not just equities which looked expensive, but fixed interest and property were also relatively low yielding. Normally, if we’re worried about equities we’ll hold more in these two asset classes but given they also seemed poor value we instead put more into alternative equity.

Last year did indeed turn out to be unusual in that most non-equity asset classes also lost money. As we mentioned in the briefing note we sent out in December, Deutsche Bank say that 90% of the asset classes they track lost money last year. This is the highest percentage ever seen in their research which goes back to 1901.

Our alternative equity funds also found things difficult but as a whole they did provide a positive return in 2018, as did property. Whilst in both cases this was only marginal, the decision to hold more alternative equity rather than bonds or equity did make a positive contribution.

Planning, not predicting

We remain committed to keeping our clients informed about what is going on in markets and what we’re doing with portfolios.

The key point to get across is that quarters and years such as those we have just had, whilst not exactly common, are also not particularly unusual.

We have to accept both the fact that they will occur from time to time, and also that we will never know exactly when they will occur. We can’t predict the future but we can plan for it. This is true from an investment point of view, where we’ll always have a plan as to how we might take advantage of volatility when it does occur.

Probably more important, is that we also factor such periods into financial planning. When you sit down with your adviser and consider what might happen to your finances in the future, we always make the assumption that periods such as that we have just seen will happen regularly.

This is why we rarely recommend anybody invests 100% of their portfolio in equities. Those who rely on their portfolios for income would have to be selling during a market dip to fund their spending, crystallising losses. This means they don’t feel the full effect of the market recovery when it comes.

We want to be doing the opposite, switching money out of lower risk assets and into stockmarkets at relative lows. After the falls we think equities now look much better value and so have topped up our holdings. This will help us maximise the gains should markets recover. We’ll then look to reduce equities again and guard against further downturns as best we can.

A note on regulations

Under the new “MIFID II” regulations which came in at the beginning of 2018, we have to write to clients with discretionary management, whose portfolios lose 10% or more between their quarterly statement dates.

This is a well intentioned rule but one which causes a few issues. Firstly, it applies to each individual account rather than a client’s portfolio as a whole. For some clients with bespoke portfolios, we may hold equities in one account and lower risk assets in another. This means we may need to write letters because the account holding equities is down more than 10%, even if the lower risk assets have held up and the portfolio as a whole is down much less.

Secondly, we also have to send a letter within 24 hours of the 10% limit being breached. Unfortunately, because of the way the platforms work we often don’t find out until around the following lunchtime that the loss has occurred. Given we have to send out the letter by close of business that day it leaves little time for us to personalise the letters as we would like to.

We appreciate that such letters can cause concern. Very few clients will have received one but if you have then please do not worry. However, please do get in touch if you would like to discuss in more detail.