Santa time - bring on the Fed!

It is funny how the mind works, isn’t it?

I intended to write another article on Brexit (and will do in advance of the January vote), but this got me thinking about economics – which is an art rather than a science and the only things that really count are PED and MUT (fuel for another article in which all will be explained). As an aside, the executives of the online retailer Asos have learnt all about PED and MUT this week and if Jeff Bezos, of Amazon fame, has yet to fully appreciate the importance of these dynamics (the ‘pile it high and sell it cheap’ model has its limitations) he soon will.

Anyway, I then digressed into the demise of the endowment mortgage and realised that this has much in common with pension plans. I was only discussing with a colleague earlier this week that neither of us will be retiring before the age of 70. This thought trail made me think about stealth taxes (worthy of yet another article) but also the perception and actuality of stock market returns. I have settled on the latter for subject matter on this occasion.

A timely parody…

Ahh, the ebb and flow of life – if only this mantra applied to stock markets! But actually it does – just in reverse. We as human beings, like stock markets, experience good times and bad times, but the key difference lies in dynamics. Our good times are catalysed by sudden events such as a new job, promotion or an unexpectedly good bonus, which tide us over for a while. Conversely, our downturns are akin to sinking in slow-acting quicksand – it can take years for us to decline to the point where we are up to our necks in the stuff...as I know only too well!

Conversely, the relentless rise of bull markets seems to last forever but, as soon as the bear begins to growl, profits can be wiped out almost instantaneously. The good ship ‘stock market’ never slows down until it hits the proverbial iceberg. But it should be pointed out that the one which sunk the Titanic did not materialise out of nowhere. The sequence began with the berg breaking off from the mammoth ice shelf in western Greenland. From here, it made a slow but relentless journey around Baffin Bay and southwards down the Davis Strait, before being picked up by the Labrador Current and eventually carried into the path of The Titanic.

Stock markets crashes are similar – iceberg warnings are received but central bankers rearrange the deck chairs and the music keeps playing!

What a timely parody this could be, today of all days, as investors look to the Federal Reserve to ignite a last-ditch Santa rally. But even good news would be bad news. The Fed has repeatedly asserted the need for interest rates to normalise. Any slowing in the pace of rate hikes is only a sign that the Fed has lost faith in economic momentum – and when was a deceleration in growth ever good for corporate profits?

If corporate executives cease their share buyback programmes, who becomes the investor of last resort?

Back on the east side of the pond, the FTSE 100 has retrenched below the 7000 points level, but relatively few seem to appreciate the significance of this. The point is that the index is now at very similar levels to when Prince was partying like it was 1999 (because it was).

Of course, such a comparison is overly simplistic because it does not take reinvested dividend income into account. But, it is worth pointing out that the early Footsie trackers of the 1990s were based solely on capital price movements. Moreover, in the absence of ETFs, the index was otherwise uninvestable – particularly to retail investors. This enabled the investment arms of high street banks to levy a front-loaded fee of 5-6% and an annual management charge of 1.5% - imagine locking your capital into one of those for the last two decades!!

The sidewinder sleeps tonight…

Japan provides a very useful example here because, since peaking 30 years ago, the Nikkei and Topix still languish well below those lofty levels. But, with dividend income reinvested, investors would at least be showing a small profit. All of this emphasises the importance of dividends and price valuations. No surprise then to have witnessed the fall from grace of technology stocks this year. 

I am not one for making stock market predictions - well, actually I am, but it is merely a subjective view. However, it is difficult to envisage global stock indices doing any better than flat-lining in the foreseeable future. Of course, this doesn’t mean that investing in stocks per se cannot be profitable – two particularly salient points spring to mind.

Firstly, emerging markets have endured a bloodbath this year with the MSCI EM Index (in USD terms) down almost 25%. Yet, the Middle East markets of Saudi Arabia and Qatar top the list of 2018 winners with growth of around 20% or more. Every year spawns significant outperformers at the regional or country level.

Secondly, in US stock market terms, the period 1976-1982 was known as ‘the great sidewinder’ because the S&P500 flat-lined. However, the share price of around 20% of index constituents appreciated by 100% or more over this period (obviously counterbalanced by shocking losses elsewhere). Sometimes ‘buying the market’ per se is not the best approach – stock picking (and asset allocation) can add substantial value.

1987 and all that…

Everybody knows that the stock market crashed in 1987 and most are familiar with the term ‘Black Monday’, in which US stock indices shed 12%. The following day they fell another 11%. Of course, you can’t simply ‘sum’ these two figures for a 23% loss as the Tuesday fall came from a base level of 88 rather than 100 – this is called ‘negative compounding’. However, over the year as a whole 1987 witnessed marginal gains in stock prices.

As we await the Fed, the MSCI World Index (USD terms) is down 9%. In the absence of a spectacular Santa rally, 2018 will prove a worse year for investors than 1987 – and that, folks, is a fact not an opinion!

Usual caveats apply. These are my own views and I am not writing in the capacity of a representative of my employer. However, if you have enjoyed reading this, please like or comment.