80-20 Investor  

Investors hoping for a Santa rally and a strong December for stock markets in line with Christmases past have been left wanting. At the time of writing the story of investment markets in December 2018 has been more Ebenezer Scrooge than Santa Claus.

Historically December is the best month of the year for stock market returns. Since 1994 the FTSE 100 has finished up, on average, 1.89% while the S&P 500 has been up a shade under 1.5%. The chart below shows what a disaster this December has been for equity markets globally.

It's caused Investors to become haunted by the Ghosts of Christmas past, with parallels being drawn with some of the worst periods in stock market history:

  • This December, US stocks are on for their worst December since The Great Depression in 1931
  • If the US stock market falls another 0.2% before the end of December it will be the worst monthly decline since October 2008
  • The Dow Jones has now endured three months of more than -4% declines. The last time that happened was... you guessed it... 2008
  • Out of 8,715 trading days since 1984, Thursday was the 9th worst day for the number of US stocks hitting 52-week lows. The other 8 days were all in October 1987 and October/November 2008. Or in other words, the falls are getting worse and are reminiscent of the days during the aftermath of Black Monday (1987) and the financial crisis in 2008. 
I could go on and on but you get the picture. The signs are ominous. Of course, this is not just a US phenomenon. There is a sense that the US stock market may now finally be playing catch up (or I should say 'catch down') with other global stock markets. The rest of the world, particularly emerging markets stocks, have already endured a lot of pain this year after not recovering from the sell-off in the Spring. China, South Korea, Turkey, Italy, Germany and Mexico are just some of the global stock markets already in the bear market territory (i.e. down more than 20% from their 52-week highs) with many others within a whisker of joining them including the tech-heavy Nasdaq in America. The table below shows the year to date performance of key stock market indices. You can see the damage globally.
Index Year to date price moves %
S&P 500 in US -7.71
MSCI AC World -10.28
Nikkei 225 in JP -11.42
MSCI Emerging Markets -12.67
FTSE 100 in GB -12.69
FTSE Eurofirst 300 in EU -13.12
MSCI AC Asia ex Japan -14.5

This week, as we entered the final stretch towards Christmas, stock markets capitulated further, particularly in the US. The blame has been firmly placed at the door of Jerome Powell, the Chair of the US Federal Reserve. In the face of growing signs of economic weakness, the Fed raised interest rates at its 19th December meeting. A widely anticipated but feared move. The Fed also suggested that there is still scope for a further two interest rate hikes next year. While this is lower than the 3-4 hikes which had previously been touted, it wasn't dovish enough for investors. In last week's newsletter, I questioned Powell's ability to soothe the markets with his words or at least with the same level of skill that his counterpart at the European Central Bank, Mario Draghi, possesses.

Perhaps it should have come as no surprise then that Powell's answer to a question on the Fed's plans for unwinding its QE (money printing) programme sparked the next leg of the market sell-off. You may recall that the Fed never actually printed money when it embarked on his Quantitative Easing (QE) plan which was aimed at rescuing the US economy in the aftermath of the financial crisis. Instead, it bought US Treasuries using money digitally created out of thin air. By buying these low-risk investments from banks it was able to flood the economy with money. This money then made its way through the financial system as banks became encouraged to lend it to consumers and businesses while investors were incentivised to take more investment risk as the return on US Treasuries and cash deposits fell. The result was that asset prices, in particular stock market prices, soared. Yet the US Treasuries that the Fed bought have a fixed term at which point they mature and the money is paid back to the holder (in this case the Fed). Rather than keep reinvesting in new Treasuries to maintain the level of QE, about a year ago the Fed decided to let them mature instead, so reducing the size of its Treasury stockpile. This effectively started slowly removing money from the financial system. Think of it as a form of autopilot monetary tightening, which isn't very aggressive. Eventually, if they leave the autopilot on then all the Treasuries will mature and QE will have been completely unwound. 

The question that caused a stir at the press conference this week was whether the Fed would now turn-off the autopilot QE unwinding process in the face of the recent weak economic data. However, Jerome Powell said he saw no reason to change course at all. The market interpreted this to mean that the Fed was going to raise rates and unwind QE at a predefined rate irrespective of whether the economic data suggests that this would be a bad idea or not. Think of it like an airline pilot sitting with his feet on the dashboard telling everyone to ignore the warning alarms and the approaching mountainside because you can't crash using the autopilot.

The result was that US stocks fell more than 2% immediately after the Fed's decision, having been up more than 1% ahead of the meeting. It was the most violent reaction to a Fed interest rate decision since 1994. Investors are haunted by the past mistakes of previous Chairs of the US Federal Reserve. In a recent weekly newsletter I explained that some economists blame the Fed's aggressive rate rises heading into 2000 and 2007 for causing (or at least amplifying) the economic and stock market collapses which followed the dotcom implosion and the global financial crisis. The chart I included in that newsletter showed the impact of those mistakes on the stock market. It is very sobering. 

Is Jerome Powell ignoring the lessons of the past and set to usher in the next bear market in stocks? Or could he learn the lessons of the past and change the future before it's too late?

Following Powell's comments and Trump's threat to shut down the US Government if he doesn't get the money to fund his wall, US stocks broke down through the lows achieved in February. If you go back and revisit my technical analysis piece from October, now with the benefit of hindsight, you can see the worst case scenarios are playing out and markets continue to weaken.

One characteristic of this stock market sell-off has been the general lack of extreme fear. The market fear gauge (the VIX) has been trading between 18 to 25 since October. Bear in mind that the long-term average is around 20. That doesn't scream panic which perhaps explains why the bottom of the market has so far remained elusive. However, fear is showing signs of picking up (the VIX jumped to 28 on Thursday) but we've not yet seen the blind panic that usually precedes a market bottom.

In fact, JPM summed up the situation quite nicely by saying "stocks may be very oversold and sentiment is awful but unfortunately the twin vacuums of news and liquidity are making for a toxic environment right now". Or in other words, things could get worse before they get better.

That means that my decision to maintain a low equity exposure in my £50k portfolio, alongside large cash and bond holdings, as well as a short European equity position, is paying off. My portfolio is down only 1.54% in December, outperforming the -3% return achieved by the average professionally managed fund within the Mixed Investment 40-85% Shares sector. All the while the market weakness continues, this gap will widen.

Of course, given such a dreadful December for equity markets, the odds of some form of rebound increases even if it is a brief rally before a next leg lower. If we are to get some form of relief rally then we need to hold above 2,478 on the S&P 500 for starters. While all markets have their own individual support and resistance lines, a rally in US stocks will lift the mood globally.

But what about Christmas future? With only a few trading days left in 2018 thoughts turn to the outlook for 2019. So next Saturday you will receive an article with the outlook for 2019, including investment bank predictions of where the US stock market will be this time next year. I will also highlight some of the macro themes that will likely be important in 2019. 

2018 may not be remembered with fondness by many investors but it has provided a much-needed dose of reality after an incredible 2017. 

Asset Allocation Tool

If you are currently using a saved down version of the 80-20 Investor asset allocation tool then please download the latest version. On the previous version, the data for a few Legal & General funds was not pulling through correctly and has now been rectified.

Over Christmas

During the Christmas period, the stop loss alerts will still be monitored in the same way as normal and I will produce a new BOTB and BFBS at the start of the New Year. On Saturday 29th December you will receive an article discussing the investment outlook for 2019. I won't be able to respond to any emails or Chatterbox questions until I am back in the office on 2nd January. So put your feet up, enjoy the break from investing and the time with your family and friends. Happy Christmas!

Data update

As usual, I have updated the Best of the Best and the Best Funds by Sector tables.

Best Wishes
Damien Fahy
80-20 Investor & founder

Damien is regularly quoted in the national press including:
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