Well Santa didn’t deliver on my Christmas wish.
December was incredibly volatile with markets around the World tumbling. New Zealand was, once again, a strong performer relative to other markets only falling 0.1% for the month. In contrast for much of the World it was a very weak month. The US S&P 500 share market index fell 9.2%, Europe was down 5.4% and China down 5.2%. Overall, in New Zealand dollar terms, global markets were down 4.7%.
As is often the case government bonds acted as a port of calm in the storm with falling interest rates leading to capital gains for fixed income investors. This is exactly why we recommend portfolios are diversified between shares and fixed income for most investors.
The fall in share markets over the fourth quarter was large by any measure. Using data from the United States the 14.0% selloff in S&P 500 was the 9th largest Q4 sell-off since the 1920’s. In the last 90 years, only the most extreme circumstances have witnessed a selloff greater than last quarter. Five of those episodes were during the Great Depression when the unemployment rate was over 15%, not the current 3.7%. One episode was the fourth quarter of 1941, when Pearl Harbour was attacked and the US entered WWII. The 1987 stock market crash was another episode. Finally the fourth quarter of 2008 saw a 23% collapse as financial markets essentially seized up amid multiple crises.
This highlights the conundrum for investors as we enter 2019. The magnitude of recent share market falls is more typically associated with periods of extreme economic or social/political stress rather than the relatively benign conditions prevailing across much of the globe right now.
Of course the market could be ahead of the game - falling before any bad news materialises in measured economic activity.
There are plenty of risks lurking in the shadows that provide cause for worry. This list is by no means exhaustive, but higher official interest rates in the United States, slower US economic growth (these two are somewhat mutually exclusive but logic doesn’t get in the way of fear!), Brexit, high levels of corporate debt, ongoing trade wars and weakness in China have all been highlighted to explain the market’s fall.
Investors are on edge. Never over a Christmas break have I heard more discussion about the share market while sitting in cafes sipping on my customary long black than I have this year.
Some of the fears being discussed are more real than others in my view. It is the performance of the Chinese economy that remains the key to the health of the global economy in 2019 as I see it.
The Chinese economy was weak 2018 and this may continue into 2019. This has an impact outside of China. South East Asia and Japan are in many ways are a proxy for weakening Chinese industrial production and further afield, for Europe, a weak Chinese consumer makes life very hard for the high end consumer electronics and auto firms which are important engines of these economies.
Apple’s recent profit guidance downgrade echoed this sentiment with the company noting that over 100% of its year on year worldwide revenue decline occurred in greater China. While Apple has its own issues in China, with particularly strong competition from Huawei, its announcement speaks volumes about the health of the Chinese consumer. Further downgrades from companies selling to Chinese consumers should be expected in the first quarter of 2019.
Despite these risks, data out of the US remains healthy, with consumers very buoyant, and, while we expect the economy to slow, an outright economic recession is nowhere near our base case. Europe looks likely to bumble along with sub-par, tepid growth. The economic picture is cloudy rather than stormy.
Despite that share prices have fallen significantly. Opportunity and clear value is beginning to be apparent in some sectors of the market but this is accompanied with higher than normal uncertainty.
We are balancing those competing themes and for now remain cautiously positioned, with less invested in shares than would be typical over the longer term. Markets are likely to remain volatile until some of the worries assailing them are resolved.
Those of you who attended the roadshow might remember that I quoted hedge fund investor Stanley Drukenmillar who notes that there are times in markets to “be a pig.” By this he means investors should be ready to take advantage of fear and associated weak prices to buy shares in great companies. This is not one of the times as yet.
That said 2019 is the Chinese Year of the Pig. In Chinese culture, pigs are the symbol of wealth, their chubby faces and big ears are signs of fortune. I suspect that at some point over the course of this year the time for courage will come and investing more heavily in shares that have been beaten down will be richly rewarded. For now we are waiting and watching.