As a follow up to our note from a month ago, Is it Different This Time?, we feel it is an opportune time to reiterate a few observations and offer our opinion on recent market volatility.
First and foremost, this is systemic, meaning it is affecting nearly all markets. The riskier the asset, the greater the impact, and even low-risk investments have experienced outsized market declines. When a stock, bond or commodity experiences significant price change in a short period, the common thought is that this is unique and someone always knows more and is taking advantage of the situation. With declining prices, no one wants to be left holding the bag if impairment is part of the equation. Act first and ask questions later is the common mindset that impacts prices in the short-term, but usually has little bearing on value over extended periods of time.
This is the first year since 1972 where virtually all major asset classes will post flat or negative returns for the calendar year. Until the end of September, only US stocks provided positive returns. Foreign stocks, bonds (government, corporate and foreign) and commodities have all declined this year and most significantly in US dollar terms. Since US stocks began their rout in October, the only beneficiary has been Treasuries, which as of this writing now show a small gain for the year.
A leading factor in the near-term is liquidity or, in other words, the impact a transaction has on market price. Most investors fail to appreciate the seasonal effect this can have. As year-end approaches, liquidity naturally declines as banks and other financial institutions ‘pretty-up’ their financial statements for regulators and annual report snapshots. This is nothing new and in some years, has had a greater impact than in others. 2018 is one of those years. Those seeking to take advantage of tax-loss selling at year-end may find that they pay a steep price to find a buyer for their shares or bonds.
In public markets, the last sale, no matter how small, determines the value of the whole issue. On any given only a very small percentage of ownership actually trades. Absent new information, intrinsic value to a specific business does not change much from day to day.
As we have commented in the past, two of the most relevant factors in today’s markets are growth and momentum. The first is alive and well, though appears to be declining. Economic growth, which is the foundation for business activity, is likely to come in around 3% for 2018. This is the healthiest reading in more than a decade and explains why equity markets up until earlier this year have performed well. Expectations for next year, however, have recently declined and although they are still forecasted to be very healthy, the direction of the change is not likely to help market prices in the short run.
Momentum, which is beneficial when prices are rising, hurts when the trend starts moving in the other direction. This reversal started to happen mid-September.
What has caused the inflection point?
Markets do not like uncertainty and today we have many sources, including:
· China trade dispute
· Budget showdown in DC and other political dysfunction
These issues will eventually resolve and when they do, businesses will have greater confidence to reinvest and commit to future growth, which in time will drive markets back to recent highs. But don’t expect this to be an overnight phenomenon.
One of our core investment principles is that well-managed and well-capitalized businesses will continue to provide benefits to their customers and in doing so, economic returns to their investors.
Once again, all of us at EPIQ Partners wish you a peaceful, safe and enjoyable holiday season. We look forward to connecting in 2019.
Daniel Aronson, CFA Bruce Langer, CFA Ben Frey, CTP