Over the past four weeks, we saw nascent signs of an emerging market recovery before it was derailed by Turkey sanctions derailing the Lira, followed by an earnings miss by Chinese gaming company Tencent, the biggest constituent of the emerging market index.
The S&P/ASX 200 was up 0.8% in the past four weeks as earnings so far has generally been positive. We are currently in the midst of the Australian reporting season, while the US reporting season is winding down. More US S&P 500 companies have so far beaten earnings expectations compared to recent history which drove the US market higher, but the US S&P 500 pared some good gains following emerging market concerns. It is up about 0.6% over the past four weeks at the time of writing. It is still about 2% away from achieving a new record high and a new record duration for a bull market.
Other markets did not fare as well. The European Stoxx fell around 1.4% on worries of Turkish contagion as the Nikkei 225 in Japan fell almost 2% and emerging markets continued their rout, with the Chinese CSI 300 falling over 5.7%, dragging the MSCI AC Asia Pacific index down over 2%.
Bonds were largely unchanged as the US 10-year yield continues to trade around 2.85%-2.9% while the Australian 10-year yield is around the 2.6% mark.
The US Dollar continues to climb against most currencies and the Australian Dollar fell about 2% in the past four weeks to about 0.723 cents.
We are at the tail end of a very strong US earnings season that has on average shown growth of around 24%, beating the 20.5% growth expectations going into the season, but the focus has been on geopolitical issues. The Trump administration has ratcheted up tariffs on Turkish goods while continuing to threaten further measures against China and Russia. De-globalisation now looks set to be the new reality in the global economy as long as Trump remains in power, and potentially longer as he has undoubtedly made his mark on US politics. This backdrop has impacted economic growth especially in emerging markets, with liquidity draining out as investors adopt a more conservative approach in the face of higher risks.
Domestically, signs of a slowdown from the strong economic recovery we saw earlier in the year has started to emerge. Inflation came in below expectations at 2.1%, well below the Reserve Bank of Australia’s targeted range. The AIG Manufacturing Index has also fallen significantly in the past couple of months, although still indicates growth to come. The employment market also showed a net loss of jobs in July, although it does follow a very strong June figure.
Even the US economic activity indicators have started to disappoint, although they still indicated good growth over the next few months. On the positive side, US consumers could pick up the slack as retail sales figures rose a strong 0.5% in July.
In Europe, activity indicators continue to hint at a continued recovery despite industrial production falling 0.7% in June. Inflation is expected to be just around the 2% mark which means that the European Central Bank remains in no real hurry to hike rates from the current negative rate environment.
China did show multiple signs of a slowdown across the board as tariffs hit liquidity, and consumer and business confidence. Activity indicators disappointed though still showing expansion, as did Chinese fixed asset investment and industrial production figures. Chinese authorities had already responded by introducing several easing measures, but there have been reports that these measures are not flowing through to the economy due to the recent focus on de-leveraging.
Key tenets to successful investing
Distractions are widespread in the world of investing; talk of the next best thing that will make you rich, by the ever-present predictions of an imminent crash, by the worry list that constantly surrounds investment markets relating to growth, profits, interest rates, politics, etc.
Investing is not a science, despite the bountiful number of analysts and researchers punching in numbers and building complex valuation models to spit out target prices. The well-known advocate of value investing, Benjamin Graham, coined the term “Mr Market” in 1949 as a metaphor to explain the share market, but it also applies to most other investment markets. Mr Market is portrayed as being emotionally unstable, one moment he could be completely sensible, offering prices based on fundamental factors, and the next moment he could be setting sky-high prices awash with euphoria, followed by rock-bottom prices as he descends into depression. Mr Market is highly seductive – sucking investors in during the good times with dreams of riches and spitting them out during the bad times when all hope seems lost.
While it seemed like Mr Market was in a good mood for the entirety of 2017, 2018 has thus far shown that Mr Market has not been cured of his emotional swings. This may be partially due to his new friend, President Trump, often sending off the late-night tweet to calm or (usually) aggravate Mr Market.
Successful investors need to be aware of Mr Market’s current mood but must avoid being influenced by it. Taking a step back from Mr Market and looking at him from afar from time to time may be a good way to do this and remember why so many people have an interest in Mr Market in the first place.
Below are some key tenets, peppered with some timeless investment quotes to help:
1: Investing is a long-term commitment, speculating is a short-term fad
Mark Twain once said, “there are two times in a man’s life when he should not speculate: when he can’t afford it and when he can”. Investing requires a long-term commitment and patience to see a strategy to completion. Get a long-term plan that suits your level of wealth, age, tolerance of volatility, etc, and stick to it. This may involve a high exposure to growth assets like shares and property when you are young. Committing for the long-term allows you to take advantage of one of the wonders of the finance world; the power of compounding.
One dollar invested in Australian cash in 1900 would today be worth $236, but if it had been invested in bonds it would be worth $877 and if it was allocated to Australian shares it would be worth $559,281. Although the average annual return on Australian shares (11.8% pa) is just double that on Australian bonds (5.9% pa) over the last 118 years, the magic of compounding higher returns over long periods leads to a substantially higher balance over long periods.
So, one of the best ways to build wealth is to take advantage of the power of compound interest and this means making sure you have the right asset mix in your investment strategy.
Source: Global Financial Data, AMP Capital
2: Don’t put all your eggs in one basket
“Diversification is the only free lunch in finance”. This was famously said by Harry Markowitz, who won the Nobel Prize based on his research showing that diversification can lower the risk of an investment portfolio without reducing the returns.
Many Australian investors holding the domestic large caps were happy holders in the last decade, but in the past few years, they may have been looking enviously at the returns of global shares or even the smaller companies listed on the ASX.
Trying to get such swings precisely right can be hard so the trick is to have a diversified mix. But also, don’t over-diversify as this will just complicate for no benefit. Harry Markowitz’s research also showed there are optimum levels of diversification, and over-diversification can become detrimental to risk-adjusted returns.
3: Be aware of the cycle
Investment legend Howard Marks has often said, “we never know where we’re going, but we sure as hell ought to know where we are”.
Investment markets – bonds, shares, property, infrastructure, whatever – constantly go through cyclical phases of good times and bad. Some are short term, such as occasional corrections. Some are medium term, such as those that relate to the business cycle. Some are longer, such as the 30-year secular bull market in bonds that seemingly ended last year. But all eventually set up their own reversal.
The trouble is that cycles can throw investors out of a well thought out investment strategy that aims to take advantage of long-term returns and can cause problems for investors in or close to retirement. But they also create opportunities and we need to take advantage of these opportunities as they present themselves.
The crowd can be right for long periods building up to extremes, but at some point, there is no one left on the other side of the room and the crowd can only move in one direction then. We have seen this in Dutch tulips in the 1600s, Japanese shares at the end of the 1980s, IT stocks around 2000, US housing in the mid-2000s and just last year in Bitcoin.
As Warren Buffet once said the key is to "be fearful when others are greedy and greedy when others are fearful".
Source: Bloomberg, AMP Capital
4: Turn down the noise
Paul Samuelson famously said, “the stock market predicted nine out of the last five recessions”.
These days, information and news are readily available thanks to digitization and the internet. Investment markets react to all sorts of noise, good or bad, big or small, truth or lie. It is important to turn down the noise and stay focussed.
Bad news sells. Headlines are often sensationalised negative news which misrepresent the true circumstances. Take airplane crashes for instance. These often make headline news and have driven some to believe that flying is dangerous, restricting these individuals from enjoying the benefits of traveling to new countries and exploring new places. It is far more often to see plane crashes in the headlines than car crashes, but the statistics don’t lie, death by air travel occurs far more infrequently (by number of journeys) than car travel.
President Trump’s tweets are adding to the noise with markets sometimes jumping in response. He recently tweeted that “Tariffs are the greatest!” only to tweet 12 hours later in relation to the European Union that “I have an idea for them. Both the US and EU drop all tariffs.” Much of his utterances are bluster designed to get what he wants, but such gyrations cause confusion for investors.
The key is to turn down the volume on all the noise. This allows you to stay on track with your investment strategy rather than make too many reactive decisions that could throw it off course.
5: Seek advice
Given the psychological traps we are all susceptible to (like the tendency to over-react to the current state of investment markets) and the fact that it is not easy, a good approach is to seek advice via an investment service or a coach such as a financial adviser, in much the same way you might use a specialist to look after other aspects of your life like the plumbing or your medical needs. It also helps to have someone who can help you take a step back from Mr Market and provide some structure to your investment strategy.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
If this article has raised questions regarding your personal situation, please contact your Partners Wealth Group advisor directly or on 1800 333 143.