Well, that was exciting. There must have been some kind of record set in the last week of August as the media went into overdrive trying to find succinct ways to get the message across that the markets were acting somewhat turbulently. 
Black Monday was a precursor to Turnaround Tuesday, which gave way to Whiplash Wednesday not to mention Thudding Thursday. Frenetic Friday was, thank heavens, followed by that old favourite Bank Holiday Weekend. The week could be summed up as being, what is known in the trade as, a volatile one.
Not that this was entirely unexpected. Readers of our regular missive will recognise the following from August: “A Correction Is Due: A correction in the US may happen for no other reason than we have not seen one for a long time. It has been 43 months since the last fall of more than 10 per cent on the S&P 500, the third longest such streak since the 1930s”, as well as the more scientific pronouncement of “it just feels as though something nasty is due to happen”.
Price performance of indices since 1 May 2015
Source: FE Analytics
We are yet to find out at time of writing whether our other call, that of a delay to interest rates rising in September in the US -“we appear to be a lone voice when it comes to interest rate expectations in the US” – comes to fruition.
However, weeks such as the ones just gone do raise a number of serious questions and give rise to opportunities to adjust portfolios if need be.
A bout of volatility that was so severe that it made teatime and evening news headlines should give rise to a period of reflection over one’s investment strategy leading into, and coming out of, said bout.
In the portfolios that we manage, we had raised our cash levels in anticipation of some kind of correction, yet remained invested in certain equity funds because a) we didn’t want to miss out on continuing growth if our caution was misplaced and b) market timing is an impossibility on a consistent basis and anyone who claims to do so successfully every time is a liar (allegedly).
Now that the correction has occurred, we need to ask ourselves a number of questions, and answer them through the actions we now take.
Was the correction that we’ve just witnessed the main one or, a la seismic activity, an indicator of worse to come? If it was the main one, are we to expect aftershocks?
Always a difficult one to assess and never truly understood until hindsight has had its say, but the feeling is that in the short term that was probably it, but real risks exist in the short term in sufficient numbers to prevent us from rushing into the market again with the cash that we have sidelined.
What has changed in a fortnight? We knew that China was slowing and that the demand for commodities had fallen off a cliff. That is why we had exited emerging markets some time ago and why we wrote about China last month. Has it all just got better for China and the emerging markets so that we can now buy them again? Not a chance. Our opinion is that things can get worse yet and that political risks are rising across many of the emerging markets constituents.
Price performance of indices over 1yr
Source: FE Analytics
If things are not better for China and the emerging markets, and China was largely held responsible for the global sell off, why have many of the markets rebounded so solidly immediately after the main correction? Refer back to our August newsletter on the effect of China on the global economy, but in short the world continues to turn outside China. How well it turns is another question.
Central bank policy is data dependent, and data is backward looking. Credit impulse is a forward looking indicator and the credit impulse in the euro area and in the US has slowed. This indicates a slowdown in both economic blocs which, when coupled with a Chinese slow down, is not good news.
However, the Fed uses backward looking data in assessing the merits or otherwise of an interest rate move, so it could be that rates rise at the very time that the economy is going to slow, which could turn out to be an expensive policy mistake. This would not be good for markets. However, the Fed is in an awkward spot because if it doesn’t raise rates having flagged its intention to do so, the market could take fright at the reasons for not doing so. A bit of a lose-lose really.
Is the rally based upon fundamentals or technicalities? Again, a tricky one. We mentioned the phrase “groupthink” in a previous issue and the feeling is that the sell off and snap back is more liquidity-driven than fundamentally so.
Our focus will continue to be upon those sectors (rather than geographic regions) that offer potential regardless of wider macro influences.
Will we continue to invest in healthcare and biotechnology funds, even though their valuations look toppy? Yes. We don’t think anyone’s got fundamentally healthier in the past fortnight, negating the need for medical breakthroughs.
Will we continue to invest in companies who are developing security systems to protect us from the increasing threat of cyber attacks? Yes. This particular threat doesn’t appear to be receding.
Will we continue to invest in smaller companies within the UK rather than the oil, bank and mining-laden FTSE 100 index? For the time being, yes.
Will we continue to be cautious in the short term? Without a doubt.
Looking back, last summer was similar to this one in that markets demanded action from the ECB by creating a riot in the latter months. When QE began, the euro weakened, the dollar soared, European equities rose by 25 per cent and by the spring the markets looked around and said, “now what?”
They needed a stimulus that wasn’t there any more. This is largely what has happened since 2009 at various times in the US, the UK, Japan and to an extent China. Once the short term hit of the QE narcotic has worn off, a low descends as markets turn to the fundamentals for guidance. And there’s not much there to get them excited.
Not a single economy in the world appears to be in rude health at the moment.
The US are terrified of the effects of raising rates, yet ‘forward guidance’ doesn’t seem to have worked either. Japan’s target of 2 per cent inflation has evaporated once again. What do they do? Unleash yet another “biggest ever” round of QE to try to stimulate growth again? With the Greek crisis surely only on hold and the euro rising in the past month on a weird ‘safe haven’ status, how long before Draghi kick starts the QE engine again? The world has become QE dependent and no economy seems strong enough to stand on its own two feet without artificial help.
Is this the new normal? Probably. Most of our policy makers are graduates of the economic models that were written during the freak period of credit boom and inflationary times that typified the 1970s through to the mid Noughties. That is their normal and when you are in positions of extreme power it is very difficult to admit that you may be wrong or that the bases for everything you believe to be true have changed. This is why the world is quite a dangerous place.
Andy Merricks is head of investments at Skerritts Consultants. The views expressed above are his own and should not be taken as investment advice.