Carrington Investment Approach
INVESTMENT DIRECTOR, ERIC WOODWARD’S VIEWS ON CURRENT MARKET CONDITIONS

The markets have had one of their worst starts to a calendar year for several years. There are once again very large price swings taking place in both directions, however, media always tends to focus on down days rather than up days. Although markets have been weak, some of the sectors that have led the selloff rose by more than 8% in Friday’s trading. Several factors have all come together at the same time to produce these current market conditions. Below I’ve summarised the main ingredients, comment on which ones we see as more significant from a slightly longer term aspect and how we will reposition ourselves to reflect those views.

SUMMARY OF MARKET FORCES

The concerns that have driven the current volatility are:-

  • Is the slowing growth in China a problem for world markets?
  • Is the current oil price a real negative for the markets?
  • Is the banking system under pressure with negative interest rates and the possibility of defaults in the oil sector?

China is definitely slowing although by how much is very difficult to judge in a closed economy. The data does point to some slowdown, but growth could still be as much as 6%. What has been a major negative from China is the attempt to intervene in financial markets, which almost always doesn’t work and produces very negative sentiment. On the economic front some unexpected moves on the currency markets have also taken their toll quickly.

The other major impact is that despite falling prices the Chinese have continued to produce steel at high levels in the face of falling demand. This has led to very low prices, which many western companies in the sector cannot sustain and the knock-on effect is that many plants are being closed down due to being uneconomic. Long term there will be a price to pay for this as when demand does pick up, many of the companies will have gone, demand will outweigh supply and prices could rise very rapidly.

Response

The volatility and pressures that are being exerted on all Asian Markets is increasing and we will manage our exposure down from here at the opportune moment. We will be looking to add to Europe where prices are back to very low valuations; and we feel the weak currency and lower energy prices will eventually feed through to higher prices. We continue to look at our weighting in the USA and may add back here. Retail sales numbers in January tend to point to the fact that some of the cash savings from much lower petrol prices, is feeding through into spending. On an anecdotal level, on a very recent visit to the USA, I visited one of the shopping centres and I have rarely seen it so busy! It took me over 20 minutes to get out of the car park at 6 in the evening. Also my rental car, which was a 3 litre family saloon, was on a quarter full and it only took $18 of fuel to fill it. That money is getting back into the consumers pocket very rapidly, some of which is being spent.

OIL PRICE

The daily price swings in the oil price are producing very rapid price swings in the stock markets.
The current very low price began with the Saudi oil producers keeping production levels high in the face of falling demand, with a view to squeezing some of the newer high cost producers in the USA.

This failed to work as quickly as they thought, as many of those high cost producers had forward sold production. Only now is that capacity being rapidly shut down. Other producers also kept producing as they had to secure revenues to support weaker economies and Libyan supply, which was sanctioned, is now back on line.

The price of oil is notoriously difficult to predict and most analysts don’t have a good record of getting the long term figure right. The price swings have all been around 5% this week in either direction. There was an announcement on Friday from the Middle East indicating there may be some cuts soon. This prompted prices to rise very quickly although nothing as yet has actually changed.

My view is that prices may have some near term slight weakness, but will be starting to rise from current levels by the year end. This will calm markets as long as the rise is not too rapid and will somewhat help the fears recede in the banking sector. It is boosting spending power and cutting costs of high energy users, however, this is not feeding through to the markets yet as growth remains weak.

Response

We feel that prices could stabilise within the next few weeks and we could well see the recent down moves reverse quite rapidly. Although we are spending more research time looking at the absolute return space, we will not wish to sell our current holdings at the current levels. We will rebalance as we see some signs of market stability. As outlined above we will reduce Asia and Japan in favour of western markets and in particular we will be looking to the more domestic facing small and mid-cap sectors, to which we will add.

FINANCIALS

Much of the current markets negative sentiment is being driven by this sector and the whole of the banking sector worldwide has sold off rapidly. The banks’ balance sheets are significantly better in the banking sector now than in 2008/9.

Many of the participants made moves on Friday to provide some support by buying in stock and debt; and many of the European banks rose by over 7-8%. USA banks also saw rises of over 5%. One of the executives of J.P. Morgan spent over $26 million of his personal wealth buying shares in his bank, so that does indicate some participants do see this as a buying opportunity. Prices could continue to recover if the oil price stabilises or moves higher and this will be a big factor in driving short term market sentiment. The negative interest rate environment does pose a longer term problem to banks as it is much more difficult to make a margin. This could well have a longer term effect on their operating profits.

Response

Although we think the current sell off is overdone, we also consider that the risks to the sector are increasing. As a result we will be looking to significantly reduce our exposure to this sector via one of the longer term holdings, the Invesco Perpetual Global Financials Fund, once we see some recovery from the current period of weakness. We may well, as a short term tactical basis, hold these proceeds in cash while at markets settle a little.

SUMMARY

The current market is very challenging for investors and growth remains scarce. We feel that the negatives from the financial sector and oil will recede somewhat over the coming weeks and it is during this period that we will implement the changes we have outlined above. With markets moving several percent in one trading session, we will be looking to make the changes we have outlined to try to optimise both the buying and selling decisions.

If you have any questions regarding Eric’s commentary, please do not hesitate to contact us.

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