One year on from the last stock market correction
24 February 2017
It is now roughly one year since many market experts were adamant that the stock market correction of January and February 2016, was heralding the beginning of the end of the economic and capital market cycle that started in 2009. China’s and the US’ economies had slowed in their pace of expansion, the oil price hit a low of $25bbl and corporate earnings had fallen successively for the past 4 quarters. Political risks from the UK’s EU referendum and the US presidential election were only going to make matters worse and provide markets with even more reasons to trade lower.
As the chart at the top shows it turned out to have been the turning point in markets and those who did not lose their nerve but instead relied on their observations of the real economy have made handsome returns since. This is even without the effect of the post Brexit vote £-Sterling weakness, which I have deliberately neutralised in the chart, by showing the non-UK returns in local currency terms, rather than from the even more positive £-Sterling perspective.
One year on and the perspective could not be more different. The global economic expansion is back on track and for the first time is running synchronised across global regions and sectors. From a market perspective, UK and US electorates have opted for what was previously perceived as the worst possible outcomes but markets quickly changed their minds and now seem to interpret them as the most positive possible option. Commodity prices have stabilised and resource companies and the manufacturing industries most closely connected to them are once again talking about investment and expansion, instead of battening down the hatches.
The same market strategists who told us a year ago that we were heading for the abyss are now telling us that the ‘Trump trade’ is pushing stock markets to ever higher all-time highs, as investors are supposedly under the spell of what the new US president may be able to conjure up in terms of corporate tax breaks and fiscal stimulus through vast infrastructure investments.
At Tatton - in 2017 as in 2016 - we filter out as much of the ongoing market noise as we can and focus on what is really going on in the global economy. From that perspective we have regularly written on these pages that the global economy seems to have overcome a number of the headwinds which had hitherto hampered economic expansion back to the pre Global Financial Crisis levels. Particularly, the return of business confidence in the 2nd half of last year on the back of the persistency of global growth has led to the return of some level of ‘animal spirits’ behaviours in the economy. This has the potential to mobilise the vast corporate cash reserves for growth and productivity investment and we therefore gave it considerable attention.
While this may lead to a very positive impression of economic progress potential and thus further corporate earnings growth - which should reflect positively in stock market valuations - there are also more potential headwinds on the horizon than the currently bullish market sentiment may be willing to see. The risks of ill-guided decisions by the Trump administration to global trade and of acrimonious divorce proceedings between the UK and its EU trading partners have not yet led to a noticeably negative economic decision making impact. This is encouraging, but means by no means that it never will.
The rapid intra-day stock market sell-off at the end of the past week, in absolute absence of adverse news, was therefore perhaps a timely reminder that market volatility can return with a vengeance at any point. As it happens this episode was most likely a long overdue profit taking move by short term investors. However, numerous parallels have been drawn between 2017 and 1987, when economic expansion was similarly picking up and fuelled by previous commodity price falls – but market suffered a one day 20% correction in the autumn.
History does not repeat itself, but it rhymes - as we say in our profession. We would therefore like to remind investors that unnerving market corrections as we experienced the last one just one year ago, are quite probable and can be extensive during the latter part of an economic cycle. Cycles in the aftermath of financial crises have historically lasted far longer than the more frequent boom-bust cycles, but in the 9th year of the current cycle we should expect to be at least in the second half of it. The other useful old adage is that ‘cycles do not die of old age’. It is therefore entirely possible that just as in 2016, political risks do not materialise and economic progress simply carries on.
This is why we currently prefer to neither overweight nor underweight growth assets vs defensive asset relative to their respective risk profile allocations. Instead we use our investment discretion to differentiate more strongly between regions and within asset classes on the basis of price and relative valuations. This allows us to continue to fulfil our mandate to position clients’ investment portfolios such that – based on current insight - they can participate in the best return opportunities that are available for their chosen investment and risk objective in the current environment.