As we come towards the end of a turbulent week for markets, we thought there was some value in taking a step back and reflecting on what has happened and how it affects the outlook.
Since the start of the October and particularly this week, volatility in global equity markets has spiked as shown by the volatility index chart above. In the early part of the week, growth and momentum sold off sharply and was then joined by pretty much everything else in the middle and latter part in what one colleague described as an “index driven puke”. Selling from ETFs and algorithmic trading has received a lot of the blame as this can have the effect of increasing noise in this type of environment through indiscriminate selling and very high trading volumes. Quant driven hedge funds constitute also an ever growing proportion of the market – some estimates put it at around 9% of US market cap. Such is the world we now live in.
In reality, it’s hard to pinpoint exactly why the pullback happened this week. The common themes of rising US interest rates and increasing trade (and geopolitical) tensions between the US and China spring to mind as the most likely culprits. But it makes one think: ‘why now?’ We have known about the Fed’s rate rising programme for some time; it has been very well signposted. And trade tensions aren’t exactly new – the US and China have been posturing since the early part of the year. There are some signs that trade tension is now feeding through to corporate profitability though, which until now has been exceptionally strong and has been a key support for market optimism. The likes of Micron and Ford have explicitly mentioned tariffs as having an effect on earnings over the past few weeks and there have been signs that analysts’ earnings estimates are starting to roll over from their peak. So it may be that this is now starting to catch up with stocks.
There is no crystal ball to show where we go from here. Trade tensions (and consequently noise in the markets) are likely to continue in the run up to the US mid-term elections and closer to home the progress towards a deal on Brexit will also play a (small) part in the global landscape. Q3 earnings season is kicking off and releases will be scrutinised very closely as these will likely provide the clearest indication of where markets go from here. A strong batch of results, showing continued earnings growth may go some way to easing concerns.
As fundamental bottom up managers, watching markets reverse and looking at stocks of companies that we believe to be great business de-rate despite there being no apparent change to the investment thesis or the outlook for the business is painful in the short term.
But for high conviction, active managers, this volatility can provide opportunities to increase positions in companies that are fundamentally strong businesses and that can continue to grow revenue and cash flow, yet which have been overly punished by market noise. Similarly, it could be the right moment to add fundamentally attractive businesses which might have been too expensive until now to warrant an investment.
In times such as these, more than ever, it’s right that we look at our portfolios in detail and question each stock and why we hold it. Ultimately, what we believe is important in this environment is to stick to our process and our core beliefs. Each manager and strategy will follow a certain style and process that clients will have chosen to fulfil their investment needs. No portfolio can outperform all the time, that’s not the way fund management works. But it wouldn’t be right to suddenly turn one’s back on what you believe in and to start buying value stocks if you are a growth manager or vice versa. Staying true to our philosophy and remaining transparent is most likely what our clients would expect from us in more troubled times.
Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.
About the author
Luc Simoncini is a senior investment specialist in the equities team, with responsibility for providing client support and representing the firm’s equity capabilities to clients, consultants and prospects. He joined us in 2014 from Mediolanum where he led the marketing and client servicing team in Europe. Prior to that, Luc was a Client Portfolio Manager with Schroders in Australia covering global equities and was a senior investment specialist for Pioneer Investments, specialising in emerging markets. Luc studied Business Studies at Institut Supérieur de Gestion, Paris and holds an MBA from Macquarie Graduate School of Management, Sydney. He has 24 years’ industry experience*.
*As at 30 September 2018.