We saw a big sell-off in the markets yesterday – Wednesday 10th October 2018 – with the S&P down 3.3%, The Nasdaq down 4.1%. Of note is that the FAANG stocks are all down significantly – Facebook (-4.1%), Amazon (-7%), Apple (-5.6%), Netflix (-10%) and Google (-5.6%)
What caused the sell-off?:
Like most major sell-offs, it’s a confluence of factors – not one in particular. Tighter liquidity, higher rates, trade issues, weak US inflation data and heightened risks across the international markets such as China, Turkey, Australia (housing) and Canada (housing).
The markets can move very aggressively and very unexpectedly. In late January of this year, I circulated a number of podcasts highlighting the risk of a 1987 style sell-off. There was a real risk of that then, but the market had the news of tax cuts and there was still abundant liquidity.
Today, we have an even greater valuation/performance dispersion between the US market and global markets and between the US stock market and the real economy.
Are we surprised by the sell-off?: NO
We have been saying for some time that the markets – particularly some of the US names – have been looking expensive, overbought and vulnerable to a sell off.
We have seen massive divergence in performance over the past few months, between most markets and the that of the US. Usually these divergences will narrow over time – with one market moving higher or the other lower. We have now seen the market’s view of how this diversion will narrow.
Could the selloff get worse: YES
It’s worth noting that the great crash of 1987 took place on October 19th 1987 – with the US market down 22% – so almost 31 years ago, to the day.
Take a read of what caused the sell-off then and you see many of the same indicators – the market is expensive, increased dispersion of returns and performance (between markets and also between the stock market and the real economy), strong dollar and weaker trade. Sound familiar?
Central banks put USD 15 TRILLION of liquidity into the global markets – this has covered up many cracks and facilitated a massive ramp up in most asset prices. This liquidity is now slowly being turned off.
Are we sellers or buyers of equities: Sellers (as at 11 October 2018)
As investment managers we currently have very little exposure to the Nasdaq. We have cut our equity exposure after the January ramp up and have rather taken equity exposure in equity long short managers that have strong drawdown controls and are underweight US technology. Some of our exposure should be well-hedged, if not, profit from the dislocations that we are starting to see.
We have though started to like China based Technology stocks, which have started to look relatively cheap compared to their US counterparts, given the dispersion of performance. These too though, have continued to be sold down, so we will cautiously look for opportunities here.
What is next?:
The sell-off so far is nothing out of the ordinary. The question is, could it get worse or is it a buying opportunity?
We expect to see some further short-term downside. Depending on what happens over the next few weeks, we will determine whether if it is a buying opportunity or the first cracks of a larger event to come.
As we have highlighted, we expect that central banks will be quick to step in and provide liquidity to the markets all over again, should we see a significant sell off. That could result in short sharp sell down and then a recovery. While I don’t condone or recommend this approach by the central banks, it is simply speculation on what they are likely to do. More of the same. Hence we hold gold, or silver, as a hedge.
We have long advocated taking a holistic view of one’s portfolio and cutting back on excessive risk. Often times, our advice falls on deaf ears. The markets have lulled investors into that sense that it will always ‘be like this now’ – low volatility, rising markets. The reality is that it is not.
The last ten years have been an anomaly – supported by the central banks. The issues we faced back in 2007 are still with us today – most notably mal-investment and over leverage. They are just more global in nature.
So, we are going to use any sell-off to look for opportunities to take exposure. For those that are haemorrhaging, now is the time to rethink your strategy and how to reposition.
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