Investment Strategy

Urgent: it’s time to do nothing

Markets continue to gyrate. Stocks are down. Commodities are down. Oil has been down and then violently up again. At last there are quite a few apparent bargains on the table, after the poor pickings of recent years. But the uncertainty of crash season appears to be continuing. This is a time to do nothing. Patience is the watchword of the day.

As I write, US stocks are down another 2.6% on the day. The S&P 500 index, at a level of 1,921, is down 9.8% from its May and July peaks. Another 0.2% and we’ll breach the magic 10% that means everyone will be rolling out their serious faces and calling this a “correction”.

What do we call it here at OfWealth? We’d say it’s just a good start. The US stock market remains richly priced by pretty much any measure you care to prefer. We’ll remain unexcited by the prospects for US stocks until the S&P 500 falls to a level around 1,250. That’s 41% down from the peak, and 35% down from its level at the time of writing.

Why does it need to go so apparently low? Because that’s where the US stock market’s P/E10 ratio – also known as the cyclically adjusted P/E (CAPE) or Shiller P/E – would be back to its median level of 16, measured since 1881. Right now the P/E10 is still at 24.5. It’s the same story using other measures as well. (See here for detailed analysis of why US stocks are expensive, and therefore offer a low chance of being a decent investment.)

US stock market P/E10 ratio since 1881


So much for the US. Japan is already in correction mode. The Nikkei 225 index is down 13% since early August. Europe is looking similar. The Bloomberg European 500 index of big companies is down 13% since mid-July, and 15% since April. So much for QE always making stocks go up.

What about emerging market stocks? They’ve taken the brunt of the falls so far. The MSCI Emerging Markets index is down a quarter since the end of April, measured in US dollars. And it’s down a third since its post-Global Financial Crisis peak in April 2011. But with such uncertainty in the air there could be bigger falls to come. This is no time to stand in the way of jittery markets.

MSCI Emerging Market index over the past year

Source: MSCI

Commodities are taking a serious hammering as well. The Bloomberg commodity index is the lowest it’s been since 1999, as this next chart shows.


And oil is all over the place. Between 12th May and 24th August Brent crude fell from US$66.86 per barrel to US$42.69 per barrel, down 36%. But the following week, to 31st August, it jumped nearly 27% – back up to $54.15 per barrel. That’s a huge move in just five trading days – and most of it was over just three days.

No doubt a lot of professional speculators, betting on ever falling prices, got burnt in the reversal. Amateurs should certainly steer well clear.

Allegedly this huge reversal was caused by a change to the way that the Energy Information Administration calculates US production figures. Less production should mean higher prices. No doubt a lot of professional speculators, betting on ever falling prices, got burnt in the reversal. Amateurs should certainly steer well clear.

Added noise comes from speculation about whether Saudi Arabia and its OPEC chums will cut production in a bid to jack up prices again. The fact is that no one knows. Ultimately it’s going to be a political decision. And nobody should try to second guess political machinations – especially ones with geopolitical consequences.

At the same time the US dollar remains strong. Or – perhaps more accurately – other currencies remain weak. And there’s a huge amount of speculation (for that’s what it is) about whether and when the US Federal Reserve – a sort of central bank (it’s privately owned) – will finally start to raise interest rates. Only time will tell.

In fact many think that if markets keep crashing then Fed will turn around and do the exact opposite. Namely, postpone rate rises and start printing billions of new dollars – so called “QE4”.

In the meantime here’s a chart of the dollar since the start of 1995 against 26 currencies used by 40 countries that are the USA’s main trading partners. You can clearly see how the dollar has been gaining sharply since mid-2014.

Source: US Federal Reserve
Source: US Federal Reserve

Back to markets as a whole. What’s causing all this uncertainty? The only fact we can be reasonably sure of is that nobody really knows, however confident individual commentators may appear. There’s a load of conflicting and contradictory analysis and commentary out there. Even more than usual.

A strong dollar should be bad for the profits of large US corporations, since listed companies earn around half of revenues overseas. But then cheap commodities should provide a boost to the US economy – not least due to lower gasoline prices that leave more to be spent elsewhere.

Others are preoccupied with a slowing Chinese economy. But then recent steps to allow the renminbi yuan – the local currency – to fall a few percent should provide a boost to Chinese exporters.

Others point to a general malaise in emerging markets. The fear is that a strong US dollar could hit companies that have borrowed heavily in that currency, even if their governments are less exposed these days.

Then there’s a raft of other things too. The unsettled picture in the Middle East…the refugee / immigration crisis in Europe…Greece’s forthcoming elections that have the potential to destabilise European sovereign debt markets, yet again…violent protests by right wing nationalists outside the Ukrainian parliament in Kiev serving as a reminder that much is left to be solved in that country.

…the lack of consensus is a pretty good sign that price volatility will continue. People have even less clue than normal about what to expect.

The list just goes on. But the bottom line is that the lack of consensus is a pretty good sign that price volatility will continue. People have even less clue than normal about what to expect.

My feeling is that more and more people may be beginning to understand something crucial. This is that the heavy handed intervention in economies and financial markets over the past seven years by the world’s governments and central banks simply isn’t working.

You can print money to prop up markets. But you can’t invent corporate profits. You can borrow and spend. But you’re just trading the illusion of prosperity today for the yoke of higher debts to pay off in the future.

Interestingly there’s one asset that has been behaving solidly and consistently throughout this latest period of worry, and that’s gold. In fact it’s had a decent run of late. It’s risen 5% from a low of US$1,086 per troy ounce on 6th August – before the general turmoil got underway – to US$1,141 per troy ounce at the time of writing.

Gold’s solid recent performance is particularly notable given ongoing dollar strength. Often it gets sold off in the short run when other markets are jittery, as speculators sell anything to cover their margin calls, or broad commodity funds liquidate holdings as investors run for cover, or simply because the dollar is going up.

But this time, so far at least, gold is holding up well. Perhaps more and more people are realising that it’s one of the genuine safe havens in an over indebted world.

The overall market picture is one of uncertainty. Many stock market valuations remain stretched, especially the huge US market which is a little under half of world markets by value.

No one really knows when interest rates will start rising again, or if new money will be printed instead. There’s plenty of geopolitical risk around. China’s stock market bubble continues to deflate despite heavy handed intervention by authorities. And so on.

In other words, many people are getting nervous – rightly or wrongly. If you have large exposure to US stocks you should be among them, and looking to the exits.

In other words, many people are getting nervous – rightly or wrongly. If you have large exposure to US stocks you should be among them, and looking to the exits.

But for those of you that have avoided or already exited the US market, this is no time to bet the farm on new opportunities. Even on attractively priced emerging markets, although you should keep positions that were already cheap when previously bought. After all, if rates don’t rise and if the Fed starts printing money again we could be back to the races (albeit rigged ones).

The name of the game at times like this is to remain calm, be patient, and see how things pan out over the coming month or two.

Keep cash on the sidelines. Stay diversified (see here for our infographic on 50 ways to do that). Try not to take the daily market noise too seriously. Take a deep breath. Pour yourself a drink. Sit back, relax, and watch events unfold.

It’s time to do nothing.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.