Give the late downturn last night in the US and, at the time of writing this message our markets are down about 2%, I thought it timely to re-iterate some longer term investment fundamentals.
Economically, we are clearly in the “late cycle”. Unemployment rates are falling all over the world and the US has run out of workers; there are 7 million job openings for only 6.2m unemployed. Output gaps have all closed and production is running above capacity in many industries, fueling the need for more workers, more materials and more investment. Wages are starting to rise, commodity prices – especially energy – are rising and the introduction of tariffs on imported goods all add to inflationary pressure.
As a result, central banks are removing accommodation by increasing interest rates and winding back bond purchases. Recently, the United States hiked cash rates and this follows rate hikes in the UK, Sweden, Canada, Indonesia, India and Mexico amongst others – all since June. The removal of policy accommodation also has the impact of reducing liquidity in the financial system and making credit more expensive and difficult to attain. This explains the recent mortgage interest rate hikes by Australia’s domestic banks.
The reason(s) for the market malaise last night has been put down to a number of factors, largely the US/China trade issue and the Fed raising rates in the US. However, none of these issues provided any fresh data yesterday to cause the across the board market falls. In part, it has also been put down to profit taking with the sectors (namely IT) that have enjoyed the most upside over the past year also being hit the hardest (the FAANG stocks —Facebook, Apple, Amazon, Netfilx, Google) with falls of over 5% last night.
All of this with no news out of the ordinary. This highlights that markets are jittery given the run up over the past couple of years and that sentiment is driving a lot of volatility currently. Generally, when markets are euphoric, that would be more cause of concern for us as complacency often is followed by downturns and recessions. However, still some spare economic capacity, labour shortages, controlled inflation, and GDP growth do not point towards an eminent economic recession. However, “all things that go up must come down” is a fact of life and these momentary corrections, in our humble view, brings the market more in line with appropriate valuations, hopefully thwarting a major correction in the short term.
We have erred on the side of caution over the past year taking into account valuations and market optimism to ensure that our portfolios weather these types of periodic downturns better. We remain cautious for now and have positioned our portfolios so that they have a higher tilt to defensive than what the longer term risk profile dictates. Therefore, best to remain steadfast to the asset allocation that affords diversification across defensive and growth assets, across geographic borders, across fund managers, as well as across industries.