The last few weeks in financial markets have been nothing if not eventful, culminating in the biggest positive one day reaction to mid-term election results since the 1980s. Shocktober on the other hand lived up to its reputation as the worst month for equity market performance, with US markets suffering their worst monthly falls since the dark days of the European sovereign debt crisis in September 2011.
The list of October crashes is long and includes two Black Mondays; the one in October 1929 preceded the Great Depression, and the Great Crash of October 1987 remains arguably the worst single day for global stock markets. Whilst this may sound ominous, it is worth noting that statistically October has only proven to be the most volatile month (September being the worst) and has actually marked the end of more bear markets than it has heralded the start of new ones.
On a brighter note since 1946, there have been 18 mid-term elections and after every single one, stock markets were higher a year later and that’s irrespective of whoever has been in the White House and who has been in Congress. Since then, the US has had every possible political combination – a Republican president with Democratic Congress as we have today, a Democratic president with Republican Congress, a Republican president and Congress and also a Democratic president and Congress.
The market has welcomed the Democrats regaining control of the lower house for the first time in 10 years because it sees this as a much needed rein on Trump’s power. The man represents an unquantifiable risk and, tax cuts aside, many of his policies remain controversial. Post mid-terms, with a blue swathe now dominating the main population centres that surround the Republican heartland, markets can once again focus on other matters. The FED, who Trump accused of “going loco”, continue on their tightening trajectory. They have already raised rates three times this year and another rise is expected in December, despite some signs (e.g. poor housing market) that US GDP growth may have peaked at its very healthy 3.5% currently.
The political situation in the UK is no less clear, day by day, inch by inch we appear to be edging towards a Brexit deal which will then have to pass through a parliament with a very slender majority where the Unionists (who potentially have the most to lose) hold the decisive votes. Brexit secretary Dominic Raab is the latest to put his neck on the line by indicating a deal will be done by 21 November so watch this space. Whilst high profile resignations continue, any proposed deal is arguably better than the current impasse and could be well received, in increasingly polarised markets UK domestic equities stand at a meaningful valuation discount to international peers.
Of course nothing is written in the stars, and rational investors should not make investment decisions based on the day or month of the year (or indeed the political outlook) but instead base investment decisions on price.
In the main, equity prices have got a lot cheaper recently as have bonds but to a lesser degree. At the end of last week, the FTSE was down -8% year to date (YTD), Dax -10%, Hang Seng -12% and Shanghai -20%. Despite the recent panic, US markets remain up on the year, particularly the tech-laden Nasdaq, which remains up 7% YTD and where volatility has been at its highest. The significant de-rating of highly rated growth stocks is understandable when you consider US 10 year treasuries now yield 3.25%.
Not only does this present some lower risk alternatives to generate a return in dollars but the significant increase in the “risk-free-rate” means the present value of future cashflows will be less. This has significant implications for highly rated growth shares and many have de-rated considerably in a short space of time, for example Amazon has fallen from over 100x historic earnings to a “bargain” 80x. A somewhat bumpy ride for its investors, as demonstrated by Amazon founder Jeff Bezos’ stake in the company which reportedly lost $14bn in a day.
As American economist and best-selling author Robert Shiller noted the most reliable determinant of future equity returns is not the stage in the economic cycle when one invests, but the starting price one pays.
Many quality businesses are now trading below 10x earnings as is the entire emerging markets index, a valuation level from where they have historically performed strongly in future years. Perhaps this is the start of a long-awaited rotation from growth to value and from more expensive markets like the US to cheaper ones.
Or perhaps we too are loco…..
Enjoy the ride!