Do nothing….well almost!

27 January 2016

Chapters Financial Limited uses the services of Cormorant Capital Strategies for external fund and market views and with the comments noted above, we have asked them for their market views (As at 21/01/2016) at this time. I am pleased to publish their views below:

Of course, before investors can do nothing, there's an awful lot of hard work to be done by their professional advisers. That includes…
  • establishing and maintaining a contingency fund
  • matching near-term liabilities with appropriate risk-free interest-bearing assets
  • estimating capacity for loss
  • evaluating likely risk tolerance levels
  • calculating required rates of return
  • weighing a reasonably efficient and diversified mix of investable assets
  • approximating & communicating associated risks
  • selecting appropriate fund choices to accurately reflect that mix of investable assets
If all of that is done, and if all of that is reviewed regularly, doing nothing ought to be the natural reaction to recent events in the markets for commodities, stocks and bonds.

You may be aware that we have been an advocate of regular reviews since our creation in 2004.They continue:

That is because investors are…
  • afforded some immunity from the worst effects of short- and medium-term capital losses by the establishment of a contingency fund and by matching any near-term liabilities with assets that are not subject to the potential for capital loss
  • likely to invest in risky assets only to the extent that they have a material 'capacity for loss'
  • diversified so that they are unlikely to suffer the full extent of any market downturn
  • informed about the nature of risk and know they are carrying an appropriate level of risk given their long-term objectives
If investors are furiously reconfiguring their portfolios now, it is because something has gone wrong in the process outlined above.

As a point of interest, Chapters Financial has a scale for investment risk, and this can be found here:

Cormorant Capital Strategies continues:

But just what is going on in the commodity, stock and bond markets?
In short, two out of the three markets (commodities and stocks) are in what we might call a 'bear market' – that is to say that prices have fallen by 20% or so from the previous highs.




FTSE 100 (UK)

Apr 2015


S&P 500 (USA)

Jul 2015


Euro Stoxx (Euro Area)

Apr 2015


Nikkei 225 (Japan)

Jul 2015


Hang Seng (Asia)

Apr 2015


MSCI World

May 2015


Bloomberg Brent Crude (Oil)

Jun 2014


Bloomberg Commodity (a broad basket of commodity prices)

Feb 2013


Source: Cormorant Capital Strategies/Financial Express, prices in local currency over the last 3 years
As at 21/01/2016

As an aside, 'bear markets' are not at all uncommon. I expect them to occur with a frequency equivalent to once every four years and I expect each bear market to effect prices for a period averaging close to a year.

Of course it's not all bad news. Taking the peak dates from the previous table, government bonds – in spite a US rate rise - have provided some welcome gains.




FTSE Conventional Gilts All Stocks

Apr 2015


FTSE Index-Linked Gilts All Stocks

Apr 2015


BoA Merrill Lynch US Treasury

Jul 2015


BoA Merrill Lynch G7 Government

May 2015


Source: Cormorant Capital Strategies/Financial Express, total return in local currency
As at 21/01/2016

So, if your starting point is 60% in UK stocks and 40% in UK government bonds your loss over this most recent turbulent period equates to roughly 12%. Looking further back, to the famous bear market that followed the tech boom, the same mix of assets would have fallen by roughly 22%.

Might we see losses extend toward the 22% maximum? Yes, we might. That's not a forecast, it's a reasonable statement given all that we know about the behaviour of markets. In spite of my bearish tendencies though, I am not so pessimistic.

The reasons for the current malaise have been widely speculated on. The more popular narrative explains that oil prices are falling because there is a glut of supply and a dearth of demand. That is to say that OPEC are maintaining high output quotas, US shale oil production is booming and Iran has come in from the cold at a time when China's hitherto high rates of growth are beginning to moderate.

But what is really spooking commentators is the scale of the decline in prices. Crude oil stood at $110 per barrel in mid-2014 before plummeting to just $30 today. It's not just oil prices though, the declines extend to the broader market for commodities. To some, sharp falls in the commodity market, allied with sharp falls in the stock market are an omen of poorer times ahead. In the past, recessions have coincided with similar sharp falls.

But while we anticipate a bear market once every four years or so, we do not expect a recession to occur at anything like that frequency. That's because a great many bear markets occur without prompting a similar downturn in the wider economy. Indeed, I am often struck by the oversized influence investors ascribe to the financial markets in driving the real economy. If you want a really bad indicator of coming recession, look no further than the equity market.

Ordinarily, lower commodity prices might be considered a good thing for global growth since, for example, lower energy costs leave consumers with more money to spend on other things and lower inflation reduces the cost of capital for businesses.

Today though, falling commodity prices are not universally good for consumers; specifically for those consumers in many of the emerging market economies whose livelihood is to a greater or lesser extent dependent on commodity exports. And the emerging market economies are much bigger, much more influential than they once were; of the top 12 countries ranked by GDP, six fall into the emerging market bracket. So falling incomes in these economies are a cause for some concern.

There are other factors that I think have not been widely reported…

Historically, the dollar exchange rate and commodity prices have tended to draw an inverses pattern; when the dollar is strong, commodity prices are weak. Beginning in June 2014, the US dollar has gained close to 15% against the Japanese yen, 20% against the pound, 25% against the euro and 30% against the Canadian dollar. Since then, commodity prices have tumbled. So, while I agree that high supply and low demand are a factor, I also think that the dollar's strength explains some of the weakness we see in the market for commodities.

Of course a stronger dollar has accompanied rising interest rates, or at least the expectation for rising rates, in the US. Higher rates, following an unprecedented period of ultra-loose monetary policy, are certainly a source of some uncertainty for equity investors. And that uncertainty comes at a time when equity valuations could quite reasonably be described as 'elevated'.

More important than that though, I think, is that 2016 will be absent one of the more important drivers of equity market growth in recent years; central bank stimulus. Asset purchase programmes – or quantitative easing if you prefer the vernacular – have largely come to a close. The Bank of England and the Federal Reserve have brought their stimulus to an end. And while the European Central Bank and Bank of Japan are still buying assets with some abandon, their capacity to provide anything more is, I suspect, much more limited than they are prepared to admit.

In short, there are plenty of reasons why the market for equities and commodities might be displaying some signs of weakness; you don't have to invoke a coming global recession.

That, believe it or not, is good news.

We hope that these notes, although admittedly lengthy, provide a view of the recent market volatility. As always with our blogs, no individual advice is provided during the course of this Blog. If you would like to review your pensions, savings and investment arrangements then please contact the team at either our Guildford or Woking offices.

Keith Churchouse FPFS
Chartered Financial Planner
CFP Chartered FCSI
ISO22222 Certified

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.

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