9th August 2024
The recent sell-off in global financial markets has sparked the normal sensationalist media headlines and, perhaps even more annoyingly, encouraged a plethora of attempts by the great and the good of the investment world to offer explanations as to why what has just happened, has just happened. On the hyperbole, whilst recognising the moves in Japan have been of historic proportions, it’s important to remember that corrections and volatility are part and parcel of investing. When you read about markets ‘crashing’ it’s important to put things in perspective. UK equities for example, are down 2.7% (at the time of writing) from the July peak and are back at levels seen as recently as early May. On the second point, we need to remember that financial markets are incredibly complex systems with a multitude of actors with differing objectives, time horizons and sources of capital and whilst we understand the human urge to rationalise hard to explain events with easy narratives, we think it is one that is best avoided.
As regular readers will know, we believe that predicting the future is difficult and try not to engage in top-down forecasting or allow it to influence portfolio positioning. Similarly, we try and avoid the post event rationalisation bonanza that large parts of our industry seem so keen to participate in. Instead, we think our job as investors at times like this is to stay calm and focussed on the long-term objectives of the Funds. Recognising that sell-offs and volatility can also create opportunity, we will also be sifting through the ‘rubble’ to assess whether certain market moves might be irrational. This is a worthwhile exercise considering the increasing tendency for risk assets to move in lock step at times of stress, typically driven by some macro narrative, and the fact that corrections are often as much about sentiment and technical factors as they are about fundamentals.
Maybe a couple of weak US economic data points that undermine the dominant economic ‘soft-landing’ narrative should see the unwinding of crowded trades in expensive US equities many of which seemed priced to perfection. The compression in anticipated US and Japanese interest rate differentials is perhaps a valid catalyst for a rally in the Yen from extremely cheap levels. And, as the investing rules of thumb would have it, maybe this confluence of weaker US growth and a stronger Yen is bad for Japanese large-cap equity earnings with their gearing into global growth and reliance on exports, particularly following this year’s marked multiple expansion. As intimated above, technical factors certainly seem to be at play in this latest episode with the talking heads highlighting the unwinding of Yen funded carry trades, elevated retail margin positions and CTA equity longs as factors that have resulted in a significant de-grossing event, amplifying what otherwise might have been more ‘normal’ market moves.
True or not, we certainly think the sell-off has been somewhat indiscriminate and are seeing opportunities as a result. Should a portfolio of unhedged domestically focused Japanese smaller companies many with net-cash balance sheets trading on some of the cheapest valuations in history fall almost as much as large-cap Japanese exporters? Probably not. Similar question with regards to domestic UK mid and small caps. We’ve also seen discount widening in some of the listed alternatives including core infrastructure names. This seems anomalous bearing in mind negligible economic sensitivity and fact that recent falls in bond yields should be beneficial to these trusts both in terms of underlying valuations and their yield appeal versus competing assets. Sticking to our valuation conscious investment process, we have already begun work to take advantage of some of these inefficiencies.
The imperatives of maintaining objectivity and controlling how we react through episodes like this are, we believe, helped by having a well-established investment process that has proven itself through several market cycles as well as by retaining a longer time horizon. Having a patient and understanding investor base helps no end in this endeavour and we thank ours for their ongoing support. Meanwhile, we are cognisant of the fact that markets sometimes make little sense, particularly in the very short run, whilst simultaneously remaining alive to new opportunities as and when they arise.
Ben Mackie – Senior Fund Manager
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