Q3 2015 Review
Wishing you Shana Tova in the financial markets and beyond!
The last quarter has been a painful one in global markets. August was one of the worst months we have had since the 2008 crises. It is one thing to talk about expected volatility but it is another thing to experience it (professional money managers are human too).
Please be assured that we are watching the situation very carefully to protect your investments and seek opportunities. This volatility has been a long time in the making and we have commented on this expectation in previous quarterly communications, explaining how we position ourselves to optimize the relative risk and return environment.
The consensus is that this volatility is here to stay, so we need to be disciplined and hold the course. We must be very careful not to make the classic behavioral finance mistakes of selling at the wrong time so we need to stick to our long-term plans.
When I entered this industry in the 1990’s there was a popular saying that “when America sneezes the rest of the world catches a cold”. In today’s interconnected world, we might need to say, “If China, Europe or USA sneezes then the whole world will catch a cold". In Q2 2015 Europe “sneezed” with the resurgence of the Greek problem and in Q3 Europe faced the refugee problem getting out of control. As a result of this and other issues, Europe is looking like it needs some very good antibiotics... In July and August, China "sneezed" and knocked the wind out of the global markets when they took, what was perceived as desperate measures to protect their growth targets. China is a staggeringly large consumer of the world's commodities, so when they removed the pegging of their currency to the USD, a move which was arguably inevitable, it was regarded as a very weak signal; world markets panicked as commodity firms and commodity-driven currencies plummeted. This took the world stock markets down with it. The S&P fell by 13% in 3 weeks, which is one of the worst months in the last 20 years. However, to digest this, I found the following graphic by Morgan Stanley quite useful.
This shows that sharp sell intra-year declines are quite common even in years when the S&P is positive. From our point of view, China remains an important contributor to world growth and we do not expect this to change. Its emerging market nature does not eclipse its size so allocations must be cautiously and sensibly applied. Overall we expect the panic on China to abate.
Those of our readers who follow global events will know that the US Federal Reserve did not increase interest rates in mid-September as many had thought they would. This move, whilst prolonging the easier monetary policy environment, increases the uncertainty in the market and therefore interest rate driven volatility is expected to be higher leading the December’s Fed meeting. Our view is that rates will be increased in December by 0.25% and this will be the start of a slow normalization trend. This would be the first rate increase in 9 years. Whilst this is actually a positive sign that the economy is normalizing and is widely expected, we still expect to see continued rate driven volatility leading to the December decision and thereafter.
For us, one of the biggest issues so far in 2015 is the currency markets. As a result of reduced demand for commodities, prices have fallen and currencies of which produce commodities and who rely on Chinese demand have been decimated. Not only politically problematic countries like Brazil and South Africa but stable developed countries like Canada and Australia have seen their currencies loose nearly 40% from their peaks against the USD. These types of swings are so enormous they make returns on any investment pale in insignificance and it is therefore essential that global or USD portfolios have proper currency risk planning.
Corporate credibility adding to European woes
In late 2001, the Enron scandal broke out and brought the whole market down with it. The scandal led to new legislation (Sarbanes Oxley Act), new accounting rules and the disappearance of one of the “big 5” auditing firms, Arthur Anderson. The recent Volkswagen scandal in Europe appears to be bigger and we will see over the next few years major implications from this latest breach of corporate ethics and social responsibility. One of the largest and “blue-est” of blue-chip companies in Europe is going to be forced to pay heavily for this excessively greedy mistake, which lands in the lap of climate change politicians. The fallout of this is huge and we are very carefully watching our European exposure.
Brief Summary of Asset Classes Performance in Q3 2015
- The main damage this year has been in equity markets, with Emerging Market - both bonds and equities - showing the most red. The year-to-date numbers are concerning, however the March-to-date numbers are even worse as many asset classes had positive performance in Q1.
- Investment grade bonds are largely flat and straight government bonds have money in a classic "flight to quality" market.
- Some Hedge funds are performing well or at least showing decent downside protection.
- High yield bonds are showing a little damage overall, however single securities portfolios would be suffering from the lack of diversification.
Strategic Asset Allocation
We have just completed a two-month project to revise our model portfolios Strategic Asset Allocation. This is a technical process where we mathematically optimize various assumptions on asset classes, correlations, volatility and expected returns. We revisit this process periodically to verify that our core risk allocation process is in line with the latest information. The process followed is exceptionally professional and I firmly believe that Pioneer can compete against the best industry names globally. This robust process gives us the conviction and confidence to guide clients over the longer term.
Outlook for rest of 2015
As explained above, it is not very easy to be optimistic about markets, then again it never is. Goldman Sachs have recently reduced their forecast for the S&P 500 for the end of the year reflecting the feeling in the industry that 2015 will be a difficult year for equities, however with most of the damage already suffered.
In short, we expect the volatility to continue in a largely sideways market. We may see a bounce back to June levels on stock markets around December and believe that the USD is looking a little too strong against the commodity currencies so we may see some reversals there.
Emerging markets are where the high-risk high-reward opportunity lies. The “bear case” is that lower global growth will continue to shrink and weaken these countries. The “bull case” is the Emerging Markets are oversold and are therefore cheap. Clients who are interested in taking the risk should discuss this with their personal financial planner.
Israel at a glance
The Israeli market was also affected by the global sell-off of August and September and the Shekel held a modest range throughout the quarter against the dollar. Local economic news was centred around the controversial gas agreements between the various stakeholders. Whilst nothing new was accomplished unfortunately, gas discoveries off the Egyptian coast highlighted the true cost of no agreement as this will significantly impact who will be the Eastern Meditation gas supplier in the future. The final agreement that will be approved is crucial not only for the local Gas & Energy sector but also for all the local manufacturing companies and of course the local stock market. It also highlights the government's ability to manage hugely important strategic assets and public interests. Our expectations for the local market are in line with the global markets, being low interest rate and high equity volatility will continue for the foreseeable future.
The aforementioned information is not a substitute for personal Investment marketing, which takes into account the particular circumstances and special needs of each person. The views expressed in this Review should be considered as market comment for the short term for information purposes only. As such the views herein may be subject to frequent change, are indicative only and no reliance should be placed thereon. This Review does not constitute legal, tax or accounting advice, or any investment recommendation, or any offer to buy or sell financial instruments of any kind, and does not take into account the investment objectives or needs of specific investors. Although this Review has been produced with all reasonable care, based on sources believed to be reliable, reflecting opinions at the time of its writing and subject to change at any time without prior notice, neither Pioneer Wealth Management nor any other entity or segment within the Pioneer International Group makes any representations or warranties as to the accuracy or completeness hereof and accepts no liability for any loss or damage which may arise from its use. The writer and the company are unaware of any conflict of interest at the time of publishing the above commentary.