Markets have been more volatile recently, shown in the below CBOE index chart. We are not at the higher volatility figures we saw at the beginning of the year but at times like this it is important that we reiterate our investment philosophy. ‘It is time in the Markets rather than timing the markets’ where returns are maximised. In essence, holding for the long run is the preferred approach. This is shared among investment professionals globally and the best asset managers in the world.
CBOE Volatility Index as of December 2018
Underlying Media Agendas
There is always a lot going on in the media about events that could affect the markets. I think it is worth observing the fact that media channels (for example, CNBC) are highly profitable businesses, and thrive from having as many viewers/listeners as possible. As such, it is very normal for the media to comment on events and aggrandise them because it is in their best interest to capture our attention. It can cause us to act irrationally and trade more, because of how the information is being portrayed. The higher frequency of trades being placed causes both an increase in dealing costs, and reduced yields due to missing out during bull markets (profitable periods for holders of investments). The most established investment professionals realise this, and do still take note of information from the media but also combine what is being conveyed with thorough analytical and professional research to confirm views and opinions.
As we are all long term investors, it is highly likely that holding for the long run will have the most positive effect. As you may expect, we normally see the best days straight after we have had the poorest performing days. Below shows the difference in return from missing out on these days.
The US and China
Negative sentiment about the trade war between the US and China spiked over the last month when the US labelled China as a currency manipulator. The Yuan devaluation in response to new tariffs sent the stock market plunging. China aimed to gained an unfair competitive advantage using their currency as a force to shift the trade war in their favour.
US economic figures still show the country is doing extremely well. Unemployment is at historical lows, and inflation adjusted wages and GDP growth are high. One major concern is coming from the increased trade tariffs is that the increase in costs will be passed on to the consumer, driving up the price of goods and services. In simpler terms, inflation will be on the rise. Another concern is that an inverted yield curve has historically been a signal for recession. The graph below shows that short term yields are currently higher that long term yields. It means that investors are trying to lock in their returns over the long term. Usually due to fear of a recession or not being able to achieve consistent returns through other market instruments.
US Treasury Yield Curve ad of 5th August 2019
The Bank of England Financial Stability Report
The BoE releases this report twice a year. It sets out the Financial Policy Committee’s view of the outlook for UK financial stability. I thought you may like to know a few highlights from the report considering Brexit is around the corner:
- The UK banking system remains strong enough to continue to lend through economic and financial shocks that may occur
- We expect market volatility to increase throughout the Brexit transition period
- Major UK banks demonstrated their resilience to stress scenarios due to Tier 1 capital being three times higher than at the time of the global financial crisis in 2007
- Many risks to UK financial stability from disruption to cross-border financial services in a no-deal Brexit have been mitigated
- UK-based firms have made further preparations to be able to serve EU clients since the extension in March
- Some disruption to cross-border financial services is possible. Although such disruption would primarily affect EU households and businesses, it could amplify volatility and spill back to the UK in ways that cannot be fully anticipated or mitigated
- With over £1 trillion of high-quality liquid assets, major UK banks are able to meet their maturing obligations for many months without accessing wholesale funding or foreign exchange markets.
Note: Financial stability is not the same as market stability. Increased volatility and asset price changes are to be expected from Brexit. For example, the sterling exchange rate, equities, corporate and government debt and bank funding costs would be expected to adjust, and financial conditions may tighten for UK households and businesses.