Keynotes September 2015 – It Ain’t No Pun Waiting Around to Become a Millionaire

I last wrote in June and then stalled, July and August being months of such great uncertainty, with China literally crashing down (there’s the pun) from its state supported shelving, I lacked the confidence to make public my thoughts, which in any event were something of a continuing theme and an extension of my rather bearish and pessimistic views on the market, held for almost four years now, which appeared to be bearing fruit. As many others might say, quite fairly, if you hold a view for long enough it is bound eventually to come true!


If you have been following these articles then you will know that I have been searching for a catalyst that might trigger the next big fall in equity prices. We have looked at oil price volatility and sure enough the price of oil has been a factor in the recent turmoil. The possibility of a Greek or even a British exit from the Eurozone or the European Union itself and the risks to the EU of an Anti-Austerity or Anti-Establishment government being elected in Spain in November have all been discussed as factors that might herald a global crash.


China has always been another possibility and this appears to be from where majority of the downward pressure has been coming from over the summer months. Chinese shares have not been a popular investment destination for most our portfolios, given the inherently risky nature of the proposition. Our view of the Peoples Republic has been based largely on reports released in 2009 and 2010 by Hugh Hendry, an outspoken and highly contrarian Glaswegian hedge fund manager. If you have not seen him speak then this Economist interview is really worth watching all the way through.


In October 2009 Hendry, went to China and videoed empty cities and enormous amounts of business infrastructure just standing by, unused. Oddly, because there was nothing wrong with the video, except I understand it was filmed without official approval, this video is apparently no longer available to view online. You can see something similar here though.


Hendry drew the understandable conclusion that the Chinese authorities were creating infrastructure, literally building cities and business parks that no one would occupy, possibly ever. They were giving the illusion of growth and creating a property market bubble that would eventually burst, dragging the Chinese stock market down with it and eventually causing the next global stock market crash.


Hendry held to this view until 2013 when he abandoned his famously bearish attitude and invested heavily in Chinese stocks. This was a complete turnaround and he has come out more recently and said that in his opinion the global bull market will continue in the longer term. He told a New Zealand investment conference in April this year:


“I am also absolutely persuaded that the global economy remains so fragile that modern monetary interventions are likely to persist, if not accelerate. They will, therefore, continue to overwhelm all qualitative factors in determining the course for stock prices in the year ahead.”


What Hendry is saying is that government and central bank intervention, in the form of quantitative easing and low interest rates, is what is propelling global markets higher and higher. Almost no matter what happens, so long as governments and their central bankers are prepared to intervene there is no stopping the markets.


It’s brave to change one’s mind, particularly in respect of very fundamental views that you eventually believe are wrong but I think it may prove to have been a mistake for Mr Hendry when it comes to China. Whilst it is clear that Quantitative Easing and low interest rates have stimulated economic recovery and investment markets have been the beneficiaries of the resulting liquidity, I think we now seeing that even government and central bank intervention cannot prevent overvalued markets from falling back to their mean (average) values, no matter how difficult this may be to predict in advance. Of course the extent to which this is the case can really only be judged with hindsight but it does seem likely that what we are seeing in China is an unravelling of what he himself seemed to be predicting back in 2009.


My feeling is that there is a building momentum of unrest, uncertainty and fear and a tipping point is being reached because that is the natural order of things when it come to human behaviour in the share markets. These are after all, the most liquid and frequently traded markets in the world. A bazaar in Morocco has nothing on the global stock exchange systems. Electronic trading only exacerbates the volatility. Whilst Government and central bank monetary policy in the form of QE and other manipulation clearly has an effect, I think it has fuelled an illusory extension to what would have been a recovery from the 2007 – 09 crisis anyway. That is to say, it is human greed and fear that propel the markets and those emotions can be manipulated and supported by government and central bank actions.  Ultimately, what goes up must come down!


Whether this is the big crash that I have been expecting is yet to be decided. So far the FTSE World Index has fallen by only -17{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} from the peak in mid-April and has in the last two weeks bounced back slightly. This still is not as much as the fall in July and August 2011 when the index fell by almost 20{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} in just 5 weeks. However, the current fall has lasted far longer, now almost 5 months and that makes it far more of a candidate for the serious correction we have been expecting.


How much further the markets move downwards is of course completely impossible to predict but there seems to be a significant change in the way that information is being acted upon by the participants. Until now poor economic data was most often seen as a positive factor that would help to keep the central bankers feeding the markets liquidity through low interest rates and quantitative easing. Now the expectation is that central bankers will raise rates and stop QE regardless of conditions, although I think this may prove to be false in the short term at least. Nonetheless, even if we see a recovery now (today the FTSE100 closed down by more than -1{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} and S&P500 is currently up by more than 0.5{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072}) I feel further falls are likely where markets become used to the downward motion and further pessimism grows out of the fear that many shares are indeed overvalued and company profits cannot keep rising if the world’s largest economies are experiencing a reduction in consumer and business confidence. But this is speculation. What is important is that our portfolios are well diversified, built to withstand such events and that cash that has been set aside as a hedge against equity and possible bond market falls can be employed to buy these assets more cheaply for the basics of investing are that we need to buy low and sell high. Anything else will result in a capital loss and the first principle has to be not to lose clients money.

Chris Welsford

10th September 2015

Important Risk Warning – Please Read

It is important to understand that this report is not intended as specific investment advice, only my opinion in broad generic terms, designed to provide a flavour of the markets and possible future outcomes based on the possible evidence at our disposal.

The value of investments can fall as well as rise and they are not guaranteed. Past performance is not a guide to future returns and you may get back less than you have invested.

If you are at all concerned about your specific situation and the investments you hold and you are not due a review soon, then you should contact us as a matter of urgency and we will review your attitude to risk and your portfolio to ensure it meets your requirements and is adequately protected from the prospect of a share market crash.