The Weekly - Let me embrace thee, sour adversity...

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03/09/2019
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... for wise men say it is the wisest course.

The current environment feels very much like that which existed ahead of the millennium bug where experts suggested that on 1 Jan 2000, computer systems were going to shut down, unable to cope with the date change. Whilst planes didn’t fall out of the sky and the lights didn’t go out, it did mark the beginning of the end of the technology bubble which had been fuelled by companies spending billions on preparation which became an obsession for shareholders. Those companies that didn’t spend were viewed as negligent and those that did, even if it resulted in large exceptional expenditures, were viewed as prudent. In the end, the whole issue passed by with barely a murmur. Whether that was as a result of the excess spending and obsessive preparation, we will never know. What we do know, was that it was the preface for the bursting of a bubble which led to a halving of the stock market through to March 2003, as IT expenditure fell, excessive earnings expectations were exposed, and confidence collapsed. 

Whatever transpires, we are going to see a week of turmoil in Westminster. If there is a deal to be done, and some amendment to the backstop is possible, then we will find out shortly.  

Extreme national events often-present opportunity, as human irrationality involving fear is evident and that affects valuations. At the time of the technology bubble it was greed that had built the bubble and the chasing of insatiable demand. For the UK market, we have fear taking hold and this has affected demand for UK stocks from the international investor, to the extent that the UK is one of the least owned developed stock markets in the world and the valuation and recent performance support this. (Source: Merrill Lynch) 

If you were of the view that a Brexit deal was achievable by 31st October, then you would want to focus on UK domestic industries which have been affected such as housebuilding, commercial property and retailing. However, one big point of caution exists. Even if we do achieve an agreement on some change to the backstop, we then begin the negotiations around our EU trading relationship up to the end of next year. This was always supposed to be the more challenging part compared to agreeing the withdrawal agreement, so any relief bounce could be short lived – there would still be plenty of debating to come. 

The alternative of a no-deal Brexit would likely lead to sterling falling further from its already depressed levels but at least we would then have a clean break to start negotiating with all countries of the world, including the EU. Who knows, perhaps other non-EU countries would be prepared to undercut the EU and we could well benefit. The interim may be the painful bit. This is when there may be adversity that may need to be embraced. 

Experience tells us that buying undervalued assets in the face of adversity is the hardest thing to do as an investor, but often the most profitable. The revered Warren Buffett has often been quoted as saying it is wise to be ”Fearful when others are greedy and greedy when others are fearful”. This feels like such an occasion although there could be more desperation to come and the nadir may lie ahead. That said, there is a risk that a deal is achieved, and we are currently at that nadir – only history will tell.. (Source: Investopedia) 

It is a frustrating fact of providing investment advice that investors are most reluctant to invest just at the point when they should be investing. When the skies are blue, earnings are buoyant and confidence high, investors are often keen to invest, just as indices are hitting or close to highs. When the opposite is true, investors prefer cash and capital preservation investments such as gold and bonds, even if the latter are offering negative yields, as now. Over thinking the potential catastrophes and the reasons behind the valuation discount leads to reticence and indecision, through fear of losing money. This emotion can lead to far more regret than missing out on potential gains. 

So, whilst our politicians are wrestling with the no-deal adversity, investors are free to embrace it by voting with their wallet, if they have the stomach for the apparent risk. Investment risk can be measured by fundamental analysis of the numbers; measuring it through emotion and fear is a sure way to miss out on opportunity. The first approach says there is value in the UK equity market, the second says the opposite. Becoming emotionally attached to an investment is irrational and dangerous, becoming emotionally detached is exactly the same. The wise man recognises this within himself and overcomes it to embrace the opportunity presented by the adversity. 

US-China trade war escalates on fresh tariffs 

The trade war between the world’s two largest economies picked up the pace over the weekend after the US introduced new 15.0% tariffs on $112.0bn worth of goods yesterday. Whilst previous tariffs have predominantly targeted the manufacturing sector, President Trump is now targeting consumer focused businesses. The move is expected to cost American households in excess of $800 per year with items ranging from clothing to electronics all affected. China responded with its own measures on $75.0bn of US goods including crude oil for the first time and the two sides now appear to be further away from agreeing a deal than ever before. Further US tariffs are expected before the end of the year. 

Sovereign bond yields continued to inch lower particularly at the longer end of the curve. The US 30-year maintained its downwards trajectory into record lows even briefly slipping below the rate offered on the 3-month treasury. The 10-year treasury yield also spent more time below the two-year yield before concluding the week 2 basis points lower at 1.51%. Domestically, the 10-year gilt yields remained unchanged at just 0.48%. 

Sterling endured another volatile week with the currency impacted by the Government’s decision to prorogue Parliament for a month. This raises the probability of a no-deal break, although there is also the possibility there could be a general election if Prime Minister Johnson ends up facing a vote of no confidence. The pound declined by -0.8% against the US Dollar to $1.218 and was broadly unchanged versus the Euro at €1.106. 

In the equity markets, the S&P500 enjoyed its best weekly performance for 3 months albeit on low trading volumes. The US market rose by +2.8% helped by strong gains across the industrials sector. Closer to home, the large cap focussed FTSE100 rose by +1.6% with the mid-cap FTSE250 index increasing by +0.8%. On the continent, European equities also saw solid weekly gains with the German DAX30 and French CAC40 rising by +2.8% and +2.9% respectively. The Japanese Nikkei 225 meanwhile, was flat. 

Finally, from last week, oil prices edged higher on lower US crude inventories with Brent rising by +1.8% to $60.43 a barrel. Elsewhere in the commodity sector, gold posted a modest decline of -0.3%to close the week at $1,529 an ounce, although that wasn’t enough to prevent the precious metal from enjoying its best month for three years during August.

The week ahead 

We are set for a quiet week domestically in terms of economic data releases, meaning political developments are once again likely to dominate the home agenda. The Bank of England is set to present an inflation report to the Treasury Committee on Wednesday.  Meanwhile, the latest Purchasing Managers Index (PMI) figures will gauge levels of business activity in the UK’s Manufacturing (Monday), Construction (Tuesday), and Services (Wednesday) sectors. Equivalent readings are also scheduled across Europe, Japan, and the US during the week. 

The most notable publication scheduled this week will be US jobs data. As always, the first Friday of a new month will bring the latest US Labour Report, providing an updated unemployment rate, wage growth figures and payroll job creation statistics. Consensus estimates suggest all three will stay broadly in-line with trend this month; the unemployment rate is forecast to stay at 3.7%. 

 

The value of an investment with Rowan Dartington may fall as well as rise. You may get back less than the amount invested.  

Past performance is not indicative of future performance.  

Source: FE Analytics (information is correct as at 2nd September 2019) 

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The information contained does not constitute investment advice. It is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Full advice should be taken to evaluate the risks, consequences and suitability of any prospective investment. Opinions provided are subject to change in the future as they may be influenced by changes in regulation or market conditions. Where the opinions of third parties are offered, these may not necessarily reflect those of Rowan Dartington.