Markets currently appear to be in the autumn doldrums and directionless which, whilst unusual, is perhaps symptomatic of a market that isn’t focussing on the fundamentals. September and October are often cited as two months where the investor should be on their guard. Historically, significant sell-offs accompanied by high volatility have occurred in this period, shortly after everyone gets back to their desks from their holiday and begins to position themselves for the final quarter of the year. This is either locking in profits to secure their year-end bonus or positioning for the year-end, trying to make up for any disappointments which may have occurred year to date. Either way, there is often considerable activity. Historical analysis shows that September is one of the weakest months, on average, and October has delivered significantly more than its fair share of crashes and disasters. Lehman Brothers went bust in the month of September and the infamous breaking of the pound by George Soros occurred on 16 September 1992. Also, the Dow Jones experienced record-breaking declines in September 2001 following the attacks on the World Trade Centre. Meanwhile, the Bank Panic of 1907, the Great Crash of 1929 and Black Monday in 1987 all occurred in October.
The Stock Trader’s Almanac 2018 analyses monthly returns of the S&P 500 from 1950 to 2017. Within this period, October is actually the sixth best performing month returning 0.9% on average, despite experiencing two of the worst falls in history of around 20%. September is the worst performing month delivering -0.5% on average, followed by August which has delivered -0.1%.
The best months have been December at 1.6%, November and April both delivering 1.5%. Whilst the final quarter of the year has historically delivered 4%, compared to the first three quarters delivering 2.3%, 1.6% and 0.4% respectively. But as we all know, past performance should not be relied upon for future performance. These may be returns for the S&P 500, but what goes for the US equity market, usually has a significant influence on the other developed global equity markets. (Source: Stock Trader’s Almanac, 2018)
So what does this imply statistically for the rest of 2019? Well, Q4 2018 returned -13.7% achieving a distinct low on Christmas Eve which many will recall. Consequently, Q1 2019 experienced a recovery from this returning 13.5%, all caused by political tweeting from the White House. Since then, Q2 has returned 4.2%, Q3 1.6%, and for Q4 so far, October has delivered 1.6%. (Source S&P 500) So, although we have had unprecedented political influence from trade tariffs and Brexit, equity markets have been in the doldrums since the end of April when the year-end recovery petered out. Weaker during May, recovering over the summer, weaker in August, a recovery in September and then weaker into October which has now been recovered. In total since April, a return of 3.3% for the S&P 500 and 1.1% for the FTSE-100, removing any currency effect. The main return for the year was achieved during the first quarter and much of that was recovering the weakness last Christmas. This is a negligible return to a negative one after adjusting for inflation. (Source: FE Analytics)
If we go back slightly further to 30th September 2018, the FTSE-100 is up 2.4% and that includes dividends which are around 4%. The S&P 500 is up 5.3% on the same basis whilst the stand-out performing asset class has actually been government bonds despite their derisory income level. The appropriate Gilt Index has risen by 11% over that period as central banks shifted their policy stance to one of increasing liquidity as global growth has weakened. Small wonder we all feel like we have been going nowhere for quite some period of time, with politics at the heart of it. (Source: FE Analytics)
Most investors would take a sideways movement over definitive losses every time and so, given the challenges we have had in 2019, going nowhere for a year or so is not the end of the world. However, whilst global economic growth has been weakening, the central banks have been cutting interest rates in response whilst analysts’ company forecasts have been falling. What this means is that market valuations have adjusted downwards as the forecasts have come down whilst the share prices have gone sideways. So a correction in earnings without the downside, largely supported by a belief that as the central banks have cut rates and injected liquidity, this will continue to support equity markets.
Stepping back from all this statistical analysis, it comes down to a fairly simple choice as an investor. In order to make a tactical decision to take risk off the table and switch equities into bonds or cash, you have to understand what returns you could be exchanging and the opportunity cost. At the very least, you could be swapping a FTSE-100 dividend yield of 4.5%, which could potentially grow into next year and beyond, for a 10-year benchmark bond yield of 0.7% as of last week which is fixed for 10 years, after which you get your investment capital back without any growth. UK inflation as measured by the CPI for September was 1.7% for the previous 12 months. Whilst the following figures are only examples and are not guaranteed, if we project this forward then £100,000 invested in that 10-year Gilt last week, ignoring any income influence affecting the price, would be worth 15.5% less in real spending power. Adding in the annual income of £700 before tax and the total return becomes very unattractive. Compare this to the equity market where the income will be £4,500 in year one, with real dividend growth potentially increasing this into the future. (Source FE Analytics)
Of course, we all know that the negative returns from government bonds are baked in from the moment you invest and are certain if held to maturity as there is negligible default risk. With the equity market, anything can happen over a 10-year period. There is considerable talk at the moment about dividend growth slowing but nobody is forecasting negative growth which would require a deep recession and corporate hardship. Then there is also the capital at risk differential. The equity market can be a scary place and if the current earnings slowdown becomes something much more serious then the 15.5% real capital reduction offered by the bond market may look relatively attractive. However, based on the current fundamental outlook, the investor who has not already sold equities into bonds and enjoyed the superior returns since 30th September 2018 would have to be very, very bearish on the economic outlook and believe that the current earnings forecasts are at least 15.5% wide of the mark.
Given the widely held belief that the central banks will ride to the rescue in any doomsday economic scenario and the political capital that President Donald Trump has invested in his personal S&P 500 benchmark, selling equities from here when bond yields in many developed countries are negative looks like an extremely negative tactical move. There is lots to worry about out there but the frothier valuations within the technology sectors have been blown away in the last few weeks as investors have baulked at the likes of WeWork and the prices of Uber and the FAANGs (Facebook, Apple, Amazon, Netflix and Alphabet's Google) have corrected downwards. At some point, we will make headway, but we need a catalyst and possibly a correction to wash away the blues. But it will come at some point as company profits continue to drive on, with or without political assistance.
Equities post gains with another Brexit extension likely
Equity markets advanced during a quiet week in terms economic data, but a fairly busy week of Q3 earnings reports in the US.
Sterling edged lower last week as UK investors now face added uncertainty in the shape of another general election being tabled for December. The Pound drifted -0.3% versus the Euro and depreciated -1.2% lower against the US Dollar over the course of the week. The UK’s FTSE 100 index secured a weekly gain of +2.4% as the fast-approaching Brexit deadline grew more likely to see another extension.
The American S&P 500 index climbed +1.2% over the course of the week. More than 40% of the S&P 500 have now reported for Q3 earnings season with the market broadly reacting positively for the majority. Last week, shares of construction equipment-maker Caterpillar, often seen as a bellwether for the US economy, rose despite publishing fairly underwhelming numbers.
European markets also advanced last week; Germany’s DAX 30 rising +2.1% whilst the French CAC 40 climbed +1.5% for the week. The European Central Bank (ECB) left rates unchanged on Thursday in what was ECB President Mario Draghi’s final monetary policy meeting after eight years at the helm. Draghi’s term comes to an end without having ever overseen an interest rate rise during his tenure. Christine Lagarde will officially become the Bank’s first female president on November 1st.
The price of oil rose last week. The primarily European Brent crude rose +4.1% for the week to $61.41 per barrel, whilst a barrel of West Texas Intermediate climbed +4.7% to $56.38, as inventory figures took an unexpected slump.
The week ahead
Westminster will once again dominate the domestic headlines this week with Parliament set to vote on whether to hold a snap general election. The Prime Minister is angling for a vote on the 12th December although he is unlikely to get a two thirds majority in the House of Commons. We will also find out how long the Brexit extension will be; multiple dates have been discussed by the EU including November 30th, December 31st and January 31st. In terms of domestic data, Friday’s PMI for the manufacturing sector is the most notable publication whilst the Bank of England releases its monthly consumer borrowing statistics on Tuesday.
On the Continent, individual country Q3 GDP numbers are released throughout the week culminating in the official preliminary Eurozone GDP figure on Thursday. Other headline data to keep an eye on from the Bloc include unemployment and inflation, both of which are published on Thursday morning.
GDP data is also amongst the headline statistics released in the US this week with growth expected to have slowed sharply from the pace seen during Q2. On Friday, the latest labour market report is forecast to show a modest uptick in unemployment whilst the level of jobs creation is also likely to have slowed. Meanwhile on Wednesday, the Federal Reserve holds another of its monetary policy meetings with the base rate set to be cut by a further 25 basis points.
Official PMI’s are the only figures of note due from China this week whilst in Japan, there is a raft of economic data due including retail sales, unemployment and industrial production. The Bank of Japan also hosts its own monthly policy meeting although no changes are expected on this occasion.
The value of an investment with Rowan Dartington may fall as well as rise. You may get back less than the amount invested.
The value of investments may fall as well as rise purely on account of exchange rate fluctuations.
Past performance is not indicative of future performance.
Source: FE Analytics (information is correct as at 28th October 2019)
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