“And all at once summer collapsed into fall”
Oscar Wilde didn’t have anything as bland as the stock market in mind with that quote. Yet it gives a sense of stock market expectations with Autumn upon us.
In recent weeks you might have spotted scary headlines proclaiming that just ahead lies a repeat of the Great Crash on 19th October 1987. Other than it is October again, the parallels are very small indeed. You can see that if you read our “Short History Of The Great Crash Of 1987” (available free here). It covers not just the markets, but also the politics and culture of that fascinating period, Del Boy included. 1987 was nothing like 2023.
The problem is that 2023 is a much more dangerous time, certainly for markets, if not also for a host of other matters which lie beyond our brief.
To this point it’s not a disaster by any means (but for bonds, to which we will return in a moment). It has been more a period of frustration for investors. For example, in the last quarter only one major stock market was up, India at 2%. Commercial property investment trusts were down. And commodities were lower, but for oil.
However, there is a decent chance that we are now close to moving from the stage of frustration to one of fear, inflamed by much sharper falls. The scary headlines might turn out to be right, but for the wrong reasons. Nonetheless, when that occurs it will likely present you/us with some of the best investment opportunities of our lifetime, which is very exciting. But back to today, and events in the pivotal US financial markets…
US Remains Centre Stage
The main US stock market, the pivotal world market, peaked in January 2022. Since then, it has been sharply lower, and then bounced from the Autumn, latterly led by a very small number of hugely over-valued technology stocks. In fact, nearly all of the gains in the S&P 500 this year have been achieved by just 7 stocks – the other 493 have done little or nothing or gone down.
Such a narrow uptrend serves to highlight the vulnerability – there is a valuation bubble in the US stock market (akin to 1929 and 2000) and the downside is considerable.
History is our best guide as to what happens next, though sadly does not provide clues on timing – timing is the great unknown. History informs us that we should expect falls in excess of 50% occur, perhaps extending to 70-80%. Sadly, large parts of our industry are content to ignore these risks to client money, and we share our recent experience in this regard shortly. But first US government bonds, which have already suffered steep declines…
In US Bonds We No Longer Trust
To this point the greatest damage has not occurred in the US stock market, but rather in US government bonds – the world’s biggest financial market, and probably its most important.
Last year, similar problems in the UK government bonds market brought down a Prime Minister. The risks in US Treasurys today are considerably greater.
They are down nigh on 15% in the last 3 months and have fallen over 45% from the peak in Spring 2020 (equivalent UK government bonds have fallen over 50%).
Vast sums of money have not fled Treasurys to seek more exciting opportunities elsewhere, on the contrary. Treasurys have themselves become the source of massive speculation (i.e. shorting, or betting that the value will keep falling), and the regulators and central banks are VERY worried. A huge volume of such bets have been placed, $900 billion at last count.
The risks are considerable, and the knock-on effects are unpredictable. The precise risks are unknown, because there is no precedent. In the history of the United States, nothing like this has happened before.
Frustration To Fear
We mentioned earlier that we might be on the cusp of moving from the stage of investor frustration to one of outright fear – sorry!
Preparing for this isn’t helped by confusing, and occasionally reckless, messages from the investment industry. In recent months a steady stream of new clients have told us similar stories following conversations with their prior advisers or portfolio managers.
Those conversations have not been prompted by them wondering why they haven’t made much or any money in recent times (most already understand that these are challenging times), but rather because their valuations are splattered with funds and stocks down by 50% and more. The lazy and dangerous mantra we have heard over decades is repeatedly being trotted out, “the market always recovers”. And these are the same people whose clients are still sitting on losses of around 60% on the huge and much-promoted Scottish Mortgage, who left clients in technology funds in 1999 (losses 80%), and happily and uncritically recommended the funds of Neil Woodford.
We wonder how many more times we need to talk about The Japan Problem before that becomes common knowledge in our industry and amongst self-directed investors?
Their stock market is still below the peak of 1989, and during this 30+ years suffered falls of 80%+ at worst. Japan is no financial backwater – it is the third largest economy in the world, and has the second largest stock market. If this can happen there, it can happen anywhere.
Your portfolio probably represents a lifetime of carefully accumulated wealth, for which you worked bloody hard. Taking into account the clear vulnerabilities derived from the US in particular, which we have written about on numerous occasions, if a Japan-style shock is one you would rather not experience, your investments need to be managed in such a way that they can adapt to unfolding events.
Adapting To Downs, Positioning For Ups
The way in which we manage our own discretionary portfolios is around an Attack and a Defence – others might dress this up in more sophisticated terms, but this plain English does the trick. (P.S. if you have not yet switched over to our discretionary service, please bear in mind that the following strategy cannot be employed by us on your behalf, and your investments might be unnecessarily exposed. Please email to discuss.)
The Attack is about fund selection. This is our priority in 9 years out of 10 – not to be taken too literally, but you know what we mean.
In the 10th year it gets more difficult. Financial markets stumble, risks are extreme, and potential falls are very sharp e.g. stock markets falls of 50% and more, guided by the precedents. This is when we emphasise our Defence, to protect client portfolios, often the bulk of your accumulated life savings.
We take two defensive steps. Firstly, applying a stop loss e.g. on falls of a certain size, typically 10%, we sell a fund, literally stopping the loss getting bigger. Secondly, we allocate a greater proportion to cash, where returns on cash funds are now worth having.
Defence is not exciting, and we find it frustrating too – but we have learnt to be patient.
“You can’t make a silk purse out of a sow’s ear”
As noted earlier, the last 3 months have not been fruitful. But we aren’t twiddling our thumbs. We are positioning for the upturn too, always working to uncover both value and sensible entry points into those areas with the greatest value e.g. UK, Japan, China, and Asia generally.
After a strong first half of 2023, Japan has had a breather across the Summer, but displays considerable longer-term value. China flew upwards from last Autumn, when they announced their Covid unlock, but most of those large gains were lost in 2023, as their much-anticipated economic recovery appeared to stall – we are looking for opportunities to jump back on board.
Without wishing to sound parochial, which has never been our style, the UK stock markets continue to offer outstanding value, by common consent…
UK Stands Out Globally, But…
The UK stock market is “exceptionally cheap”, a “compelling case”, one of the cheapest global markets “by some distance”, and enjoys “striking” undervaluation. But its cheap status is not attracting buyers in any scale.
The UK is undoubtedly one of the cheapest global markets, but a catalyst is needed to unlock this value. The election is an obvious one. Again informed by history, on a Labour win UK domestic companies will be even cheaper and must then be bought. For this reason, and rather selfishly, we do wish they would just get on and hold the general election!
In Summary
In our internal monthly investment committee meetings we counsel each other that caution remains appropriate, which requires our patience, and also time perspective.
For example, we know the torpor of UK markets will end, and that the opportunities will be outstanding. Once markets hit an obviously significant low, whenever that might be, we will begin doing the fun bit – the Attack. All of our experience and research stretching back decades gives us great confidence in what will be achieved. We stand ready, as events can move fast.
P.S. as mentioned earlier, if you have not yet switched over to our discretionary service, the strategies set out above cannot be employed by us on your behalf, and your investments might be unnecessarily exposed. Please email to discuss.
