The recent equity market rout hasn’t presented a significant buying opportunity as there are likely to be further falls over the coming months, according to FE Alpha Manager Charles L. Heenan, who says it is the sort of market he would prefer to "dribble money into" rather than run into.
It has been a fairly calamitous few months for global equity markets, with stock markets around the world being rocked by weaker than expected growth out of China, its plummeting equity market and the authorities’ decision to devalue the yuan.
‘Black Monday’, as it has been dubbed by the media, resulted in the FTSE 100 (and many other indices) witnessing their biggest daily falls since the global financial crisis.
Thanks to other contributing headwinds such as spikes in government bond yields, the Greek debt negotiations and falling commodity prices, the MSCI AC World index is now down 15 per cent since mid-April.
Performance of index since April 2015
Source: FE Analytics
While some will have undoubtedly seen these falls as a buying opportunity given it has decreased the chance of a US rate rise next month, Heenan urges investors to sit on the fence a little longer.
He told FE Trustnet a few weeks ago that he was keeping 15 per cent of his Kennox Strategic Value in cash in the expectation of volatility and since the recent falls, he says he won’t be making any wholesale moves into the market any time soon.
“We have seen some big volatility and we would expect that volatility to continue given there is a large amount of debt still in the system and where interest rates are,” Heenan said.
“Some may want to be contrarian, but in our view, this is the type of market you want to be dribbling money into – not one which you should be running into. You have to be selective as you don’t want to be buying the market at the moment.”
The manager’s decision to hold a high level of cash, along with his focus on out of favour companies which offer a high level of downside protection, has worked relatively well for investors during the recent rout.
Kennox Strategic Value, which Heenan runs with fellow FE Alpha Manager Geoff Legg, has lost 1.5 percentage points less than its IA Global sector average over the past month, though it is still down 8.23 per cent during the period.
There are those who disagree with the Kennox duo, however.
The likes of Wouter Sturkenboom, senior investment strategist at Russell Investments, says that while the threat of a ‘hard landing’ in the Chinese economy is real, it isn’t likely to derail the economic recovery in developed markets.
He says therefore investors should buy while others are fearful.
“We do not think the situation in emerging markets warrants a significant downgrade of our outlook on global growth, especially not one of the size financial markets are currently pricing in. As a result we see this sell-off as a buying opportunity,” Sturkenboom said.
“To assess that opportunity we rely on our sentiment scores, in which we want to see our contrarian indicators signal oversold conditions. With [Monday’s] extreme intraday market volatility included we have observed those oversold conditions, allowing us to take a first step back into equities.”
Certainly, the last time the MSCI AC World delivered a drawdown of more than 15 per cent investors were rewarded for buying the dip.
The last time it happened was in August 2011 when the European sovereign debt crisis intensified and between then and the start of the recent falls, the index made a hefty 75 per cent.
Performance of index since its last 15% fall
Source: FE Analytics
However, Coram’s James Sullivan recently told FE Trustnet that the current market had similar hallmarks to the crash year of 2008. While he is unsure whether a full-blown crisis was on the cards, the former Miton manager says investors should be cautious.
“With markets trading on elevated P/E multiples, deflation or a rate rise was always going to cause some unrest – so the starting point was never favourable. Throw in the acknowledgement that China is slowing down at a much faster clip than published, currency wars only just gathering momentum, and we have a rather toxic mix.”
He added: “So is this the tip of the iceberg or are we done? We suspect there’s more to come.”
Heenan and Legg run their fund with downside protection at the forefront of their mind, an attitude which has played out well over the longer term but means the portfolio has lagged over recent years.
According to FE Analytics, Kennox Strategic Value has been a top quartile performer in the sector since its launch in July 2007 with returns 57.51 per cent, beating the MSCI AC World index by close to 20 percentage points in the process.
Performance of fund versus sector and index launch
Source: FE Analytics
The managers’ strict valuation discipline, which leads them to build up cash as markets are rising so they can redeploy at lower levels, led the fund to generate a positive return in 2008 and deliver top decile numbers in 2011.
However, it has lagged considerably in strongly rising markets such as 2009 and 2013.
Nevertheless the Kennox fund has had a maximum drawdown, which measures the most an investor would have lost if they bought and sold at the worst possible times, of just 14 per cent since launch, which is half the amount of the sector and index.
Though Heenan is generally quite cautious, he says the recent falls have thrown up a handful of opportunities. One of the best examples, according to the FE Alpha Manager, is the UK’s oil majors.
Both BP and Shell have had a torrid time of it over recent months owning to significant falls in the oil price, as a result of China’s woes and the recent agreement in Iran. These falls have also thrown up concerns about the two companies’ dividends, which if there were to be cuts would cause a real headache for UK income investors given their pay-outs are heavily relied upon.
According to FE Analytics, both stocks are down around 30 per cent over the last year, which is a major factor behind the FTSE 100’s 9.13 per cent decline as the two companies make up a large proportion of the index.
Performance of stocks versus indices over 1yr
Source: FE Analytics
While Heenan says there could well be a risk to their dividends, he says long-term investors might not get a better time to buy BP and Shell.
“Some prices are now very attractive. It’s not often that you get real blue-chip stocks like BP and Shell at these prices. Both companies face issues but if you are looking on a 10-year view, you can afford to hold your nerve,” he added.
