Y H & C Investments June 2019 Newsletter - Edition 132
In May, the Dow Jones Industrial Average fell 6.38%, the S&P 500 dropped 6.57%, and the NASDAQ Composite lost 8.71%. As the summer begins, historically the typical approach for many institutional investors has been to head to the beach for a vacation. As such, trading volumes fall and with that, volatility can occasionally spike. Over the last six weeks, financial markets have not stuck to the low volume script on fears of a slowing global economy and a deepening trade war. The sentiment is reflected in lower interest rates, with the 10-Year treasury bond reading a paltry 2.23% at the time of this writing. Even at that miserly rate, it looks astronomical compared to the near trillion dollars of negative yielding fixed income instruments elsewhere in the world. Consequently, bond buyers see the U.S. debt as a safe haven and a good alternative compared to owning paper that has negative real yields.
On the economic front, with retail sales soft and the car market going on two years of a similar trend, many analysts see the United States facing a soft patch, and maybe even the signs of an oncoming recession. The financial sector both benefits and loses from the lower yield curve as net interest margins from lending and credit cards see some flattening, while the low rates help merger and acquisitions and private equity transactions, along with prime brokerage activity. Energy prices have drifted down over the last few months as well, mostly based on the same premises of a slowing global economy and trade wars. Some see better prospects in housing, while gloom remains deep-seated in health care based on increased regulatory scrutiny and prospects for movement towards lower prices for big pharma and single-payer health care.
As for the equity market, with valuations coming in a bit but sentiment clearly trending negative, the choice between waiting for lower prices or selectively stepping into an attractive situation is one which becomes more prevalent by the day. Much depends on the specific circumstance, as always, and being diligent about the risks and why the position is a good fit should be foremost in one's mind. The higher volatility is indicative of more risk, which also means, as we are all quite well versed in hearing, the potential for more reward.
World Equities Remain Positive As Trade And Slowdown Fears Persist
(All country index data provided by WSJ.com, May 31, 2019.)
Over the last six weeks, investors have taken gains off the table to protect against the growing concern about a global slowdown. One of the peculiar events over the last few years has been the emergence of negative yields on ten-year credit investments. As an example, the bond yield in Switzerland (-55 basis points), Japan (-10 basis points) and Germany (-17 basis points) show such heightened fears of a slowdown that borrowers are getting paid to borrow capital. It leaves lenders in a tough spot, especially from a risk standpoint. Interestingly, some of the highest equity returns across the globe reside in, Switzerland (+13.2%) and Germany (+12.1%). When you get paid to borrow, why not invest in equities when your credit risk and cost is minimal? Japan’s return was also positive (+4.9%) so it appears borrowing in a country’s fixed income market and buying equities in the same market has been a winning trade, so far anyway.
Elsewhere, European indexes have returned in the +6% to +10% range for the year, with Brazil (+9.9%) and Canada (+12.6%) also strong. Looking forward, China’s trade issues with the US remain center stage for global investors, with Chinese indexes still holding up quite well (+14 to +16% for the year). Strength in global bond prices remains another key data point for those trying to navigate today’s turbulent equity markets as well.
Contrarian Thinking: Taking Gains Versus Playing Long Game?
One of the most important questions investors face is taking profits today versus waiting for a higher price in the future? Each situation is unique, and an investor has their own specific liquidity needs to attend to (or not). If we were to take cash needs out of the equation so that the investor is indifferent on cash today versus selling in the future, and let’s throw in no taxes as well (a huge assumption, I know), what should the focus be when making the crucial determination to sell or hold on?
The important issues are how is the business performing, what kinds of trends are you seeing in operations, and how is management executing versus their growth plans? You should also put a high priority on the relative level of market penetration in their most important business lines. Also, pay close attention to management incentives like stock options, restricted stock, or stock bonuses. Personally, I believe good management teams shoot for big stock moves, think in terms of hundreds of percent, not twenty or thirty. Knowing that consistently good operating performance can lead to massive gains provides motivation to hang in there after even a few years of a rock for a stock. In sum, if and when a business starts to see improvement, you will eventually be rewarded, as long as you don’t sell too early and take your two to three points with you.
Disclosure -Investing money in capital markets involves risk and could result in losing money. Past performance is no guarantee of future results. Future results are likely to be different from past performance. All equity portfolios involve risk and may lose money. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile, liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, attaining or holding the CFA credential in no way suggests performance will be superior than a market index or market return.