Markets

Having been pretty nervous and indeed pessimistic about the direction of stock markets for nearly 12 months now, I am beginning to think about what investors ought to do now we are very close to getting a resolution of some sort (ie more certainty about what will happen) on Brexit.

Once any really concrete decisions are made, currency and stock markets will react very fast, so it will pay investors to have at least thought about what options they have for action. I am assuming that most sensible investors will have taken some profits from their portfolios in 2018 or even this Spring and have some cash to invest. Those who do not still need to think about the implications for their asset mix and fund holdings.

Forming a policy for action is in my opinion a process: I don’t have any magic intuition as to what to do! So a starting point is to consider possible scenarios and then assess the way they might, most probably, pan out.

For this post, as a starting point, I am going to over simplify a little and suggest there are two possible situations after a final Brexit plan is settled (or possibly even no Brexit!). One is that the markets are relieved and like the outcome and the other is naturally that they are horrified and there is a ‘flight to safety’.

If the former situation prevails, the pound will likely strengthen and UK shares may come back into favour – the shares in the UK outside of the big global players in the FTSE 100 are oversold (ie cheap) at the moment. That would suggest it would be a good time to buy global stocks as they will be cheaper and my judgement, a rising pound would be short lived as reality sets in. As a result the overseas stocks will benefit from a windfall gain in currency terms later on. Some selected UK funds would look like a good bet too – those most hammered in late 2018, broadly investing in ‘value’ shares.

If the markets sell off and the pound tumbles, then it would be unwise to invest in shares valued in other currencies using a low value pound and there will likely be the afore-mentioned cheap investments to be bought in the UK, but they could be at real bargain prices. This is based on the observation that markets over-react to major changes in the global economy.

As to fixed income holdings (bonds), these are likely to benefit from extra demand if investors are really worried. That would push prices up. However, they are already expensive. It is also hard to know in what direction central banks will move interest rates in either scenario (not at all would be the highest probability in my view), so that is a good reason for not buying into bonds – there is a risk of sharp losses if interest rates rise more than the market has allowed.

In summary, I see opportunities to put cash to work as soon as we have decisions clear enough for markets to re-position. But I would not join any reaction of fear by buying bonds and that means avoiding most cautious managed funds.

If the title of this post is a mystery to you, let me explain:

A pump and dump operation is a fraudulent manipulation of asset prices, usually individual shares, to make a large profit from naïve investors.

Essentially, the fraudster will buy a large number of shares that are cheap because the investee business is practically worthless. They then use a variety of illegal or shady methods to increase the price. These will usually include a hard sell over the telephone to vulnerable investors with a fake story attached, placing sales with friends who will sell out later and inventing news. As demand for the shares increases and the price starts to move rapidly because the fraudster may own a large part of the total shares available for sale but only actually sells a moderate amount at this stage, more and more greedy participants can be persuaded to enter the market.

When the fraudster has unloaded enough shares to drive the price up to an implausible level, he or she and friends will rapidly sell off the large remaining stock they have. A drop in the share price initially as liquidity improves may even make unwise buyers think they are now getting a bargain!

The fraudsters bank a large profit and the share price collapses very fast, leaving many inexperienced investors with shares that are almost impossible to trade and therefore worth very little.

I mention this now because it feels to me like global stock markets are operating such a wheeze right now, albeit collectively and without a fraudulent intent.

I suggest this because global equity markets, those investing in company shares, have risen to levels last seen in the mid Autumn and seem to be heading relentlessly up. But there is no change in the global economic climate to justify this. In fact most real news is negative and many of the underlying risks are actually greater.

Many commentators are struggling to explain what element of the combined human psyche is responsible. Some say that the US and China are bound to do a good trade deal. Others say that the likelihood of the UK crashing out of the EU is reduced (although for the life of me, I can’t follow their logic). Others say that although profits are beginning to shrink and dividends might slip back, this is only happening slowly and basically ‘everything is all right’. Some point to central banks being rather worried, so potentially slowing rate rises (that is good news?!)

My feeling is that we have a situation that might be equated to the mindset of a gambling football supporter betting on his or her usually top flight team winning a major competition when they have managed to make it through the early rounds, even though the manager has just been sacked, the best players sold off and until a recent cup run, this year’s league results have been pretty rubbish. Because such a person needs a boost to justify their support, they will bet on the win. The idea of a loss after several years of glory is just too depressing. I think many stock market participants are talking up the market because the alternative is just too gloomy to contemplate.

This is worrying, because if there is a correction back to a new harsher reality, the big players will take their money off the able in a flash, at their pumped up prices, and we small investors will be left holding a lot of assets that have just been dumped. Time to increase cash weightings further? Personally, I think that would be prudent for anyone who does not cope well with short term volatility – and that will be most people.

If I told you I am using wood pellets from Russia to heat my house you might instantly think I am eco minded or getting a government subsidy or both.  The former is true but not the latter but neither are the actual reason:  the house I bought had a granular pellet boiler installed already because that is the most practical fuel option.  Russian wood pellets are the best quality and the price is sensible.

The reason why you might have guessed at the reasons I suggested is because you may be aware of a trend towards using bio-mass as a fuel on the basis of the (contested) argument that it is carbon neutral.  Trends reflect a general direction of change that has impacted enough people or processes or just data to suggest a long term impact.  The word trendy implies keeping up with changes in fashion that have become set in.

Knowing about trends in a mathematical or statistical sense is useful when looking to assess the likely direction of stock market asset prices.  In fact there is a whole industry built around the concept, called generally ‘charting’.  The number one blunt instrument of the chartist is something called the ‘moving average’ which seeks to strip out short term ups and downs in valuation and show how the direction of data is progressing in a nice smooth way.

There are different ways of adding such ‘trend’ lines to charts and the various methods of interpreting them.  The interpretation can sometimes  seem as improbable as astrology but as one might assume human behaviour across a very wide base of participants does not change much, patterns might exist, I concede.  I would however suggest that most charting methods are in fact naïve and useless because they do not account for the exact features prevailing in the financial climate of the time.

Where the trend is useful is in looking at turning points, which can never easily be detected at the time they happen.  Looking backwards and spotting quite soon the start of a new trend (an inflection point) can help one see what risk and opportunities are current. Investment fund managers often claim they are good at seeing inflection points in share prices.

An easy way to make some personal use of this concept without being a statistician is to get up a graph from a news service like the BBC of a major stock market like say the FTSE 250 (this is broader based than the 100) over a long period like 5 years.  Such charts are drawn with not too many data points so short term oscillations disappear. That can be very informative.  If you do it now, you will see we are well into a ‘bear’ market but could have some way yet to go down the slope!