Are we there yet?
After a hiatus in 2017, volatility appears to be back. Looking at a range of stress indicators, Jupiter's James Clunie, Head of Strategy, Absolute Return, believes regime change in markets could be afoot.
At the end of last year, we wrote about the prospect of a change in the prevailing market regime. For stock market investors, it seemed like a faultless year. Many indices had an uncanny ability to end each month on a new high, despite anxieties over the month about global politics and rising interest rates. So why were we worried about a potential change?
For a start, the current bull market (i.e. a market in which share prices persistently rise) has been running for nearly nine years – the second longest in history. Born at the end of the global financial crisis, this rally has been helped in no small measure by experimental central bank policies (such as quantitative easing) in the US, the UK, Europe and Japan. Estimates from the FT and International Monetary Fund (“IMF”) suggest central banks held roughly $15 trillion worth of assets in August 2017, because of these stimulus programmes.1
While the life support offered by these policies has helped heal the global economy, the flipside has been widespread complacency among investors. Stock prices have risen to historically high levels and the internal dynamics of markets have become fragile.
Now that the US Federal Reserve and other central banks are unwinding their stimulus programmes, we feel it is right to be cautious about the outlook for asset markets.
Robust to change
Many investors in our strategy will know that “robust to change” is a maxim for our approach. Nevertheless, while the strategy has tended to perform well during periods of turbulence, the past year of gently rising stock markets has been painful. Change hasn’t been forthcoming.
If you are invested in our strategy, we appreciate your patience. As a result of our stock-selection process, the Jupiter Absolute Return Fund has been leaning gently against some of the unsustainable patterns that have emerged during the current bull market.
For example, the US stock market has rallied harder than most, especially compared to stocks in the UK. We have positions that seek to benefit from a reversal of this dynamic. Similarly, exciting “glamour” stocks like Facebook, Netflix and Amazon have risen to extraordinarily high prices compared to stocks that are trading near or below their theoretical accounting values (known as value shares). We are positioned for a narrowing of this gap in valuations too.
Market history suggests these sorts of internal distortions, for example where “glamour” shares far outpace value-orientated shares, are unusual and tend to reverse over time. However, no one can predict when change will occur. There are no crystal balls when it comes to investing.
So, after the recent bout of volatility in markets, it is right for investors to ask: “Are we there yet?”
In our view, a pickup in volatility is not a reliable indicator of change on its own. To give us real confidence that conditions are evolving, we need to see evidence of stress across several indicators. Looking at our dashboard of indicators, something unusual does appear to be happening in markets.
Collapse of fringe bubbles
Bitcoin has been the fantastic object of this market cycle. If you asked what was hot, exciting and new in markets over the past two years, the answer is Bitcoin. The crypto currency surged by some 1800% last year, before hitting the wall in late December. It has since fallen over 50% from its peak. While Bitcoin is not directly correlated to stock markets, its plight could be a bellwether for a wider change in investor sentiment.
Source: Bloomberg; Bitcoin in US dollars; 02.01.2017 to 21.03.2018.
Fragile market ecology in “glamour” stocks
Overcrowding and price surges in “glamour” stocks are quite common near the end of a bull market. The delightfully named “FAANGs” – Facebook, Amazon, Apple, Netflix and Google – are the poster stocks of the current period and are potentially in a bubble.
In 1999, Microsoft, Cisco, Oracle and Amazon were similarly loved. In the early 1970s, a group of blue-chip stocks labelled “the nifty fifty” were seemingly invincible; that is, until the 1973-74 stock market crash.
While sentiment towards the FAANG stocks has started to turn this year, it is too soon to know whether this will be sustained. Nevertheless, it does appear that some investors in these companies are becoming more worried about potential risks.
Hong Kong dollar
The Hong Kong dollar, which is tightly controlled by the Hong Kong Monetary Authority, can be an interesting indicator of stress in markets. Moves to the extremes of the trading range (the Hong Kong Monetary Authority tries to keep the currency within) have historically coincided with turbulence in stock markets: for example, during the credit crisis, the darkest days of the Greek crisis, and the fall in markets early in 2016. The currency is back at these sorts of levels now.
Source: Bloomberg; HKD/USD spot rate; 03.01.2005 to 21.03.2018
There are other tell-tale signs that pressures might be building in markets. Global liquidity data from CrossBorder Capital are showing red flags for developed markets like the US. Liquidity is another word for the flow of money or capital in the financial sector. A fall in liquidity can be a sign that investors are becoming more cautious and less willing to take risk, which means stocks and bonds are potentially more vulnerable to shocks.
State Street’s Turbulence Indices can also help gauge changes in investor sentiment. These indices show usual movements between assets (stocks versus bonds, for example), and can be a barometer for stormy conditions in markets.2
However, in recent weeks we have been getting mixed signals from these indices: the data can be quite choppy – high one day, low the next – and are not always reliable.
We also monitor several types of exchange-traded funds (ETFs), including those for initial public offerings (IPO), high yield bonds and popular short positions in markets ETFs (see glossary below). These provide insights into market sentiment and signs of exuberance. However, none of these ETFs are signalling stress.
So, what can we conclude? With roughly half of our indicators showing signs of stress, something unusual does appear to be happening in markets. We must emphasise that these indicators are not tools for forecasting change. They are signals of potential stress in markets that we are using to help us try to divine our way through.
2 Source: http://newsroom.statestreet.com/press-release/state-street-global-markets/state-street-launches-turbulence-indices-assist-institutio
Evolving with the market
Market regime change is difficult to identify with absolute certainty. While conditions appear to be evolving, we plan to evolve with them rather than acting pre-emptively. This approach should help us avoid being caught out by false positives but gives us the flexibility to react quickly as the market signals grow in strength. Being sensitive to the prevailing regime has enabled us as specialist short-sellers to survive what was an amazing bull run in markets last year. As the regime changes, we would hope to expand on what we do and thrive in a change of market conditions.
Past performance is no guide to the future.
12 month rolling performance
01 Jun 13-
31 May 14
01 Jun 14-
31 May 15
01 Jun 15-
31 May 16
01 Jun 16-
31 May 17
01 Jun 17 -
31 May 18
|Jupiter Absolute Return Fund
|LIBOR GBP 3 Months
Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source
: FE, Jupiter Absolute Return Fund I Acc, in GBP, to 31/05/2018.
The fund manager can use derivatives for investment purposes, to take long and short positions based on their view of the market direction, so the fund's performance is unlikely to track the performance of broader bond and equity markets. Taking short positions creates the opportunity for a fund to deliver positive returns in falling markets, but also means that a fund could deliver negative returns in rising markets. The potential loss on a short position is unlimited, because the price of the underlying investment can carry on rising. There is also a risk that counterparties to derivatives may become insolvent, which may cause losses to the fund. This fund invests in securities issued or guaranteed by the United Kingdom which may exceed 35% of its value. The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request.
Absolute return means the actual increase or decrease in an investment, as opposed to how an investment fund might perform relative to a benchmark like a stock market index or cash rates. As such, absolute return funds typically seek to generate positive returns (over a certain period) regardless of whether the market is trending up or down.
A financial instrument that derives its value from its underlying assets. Common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indices. Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives can be purchased ‘on margin’, i.e. at a fraction of the value of the underlying asset. Thus, they are ‘leveraged’ instruments where the risk of loss can be greater than the initial outlay. Derivatives can be used like insurance contracts (i.e. to hedge market risk) or for investment purposes.
An investment designed to reduce the risk of adverse price movements in an asset by taking an offsetting position. Derivatives are usually used as hedging tools.
Buying a security with the expectation that it will deliver a positive return if its value goes up or a negative return if its value falls.
Short-selling involves the sale of an asset that has been borrowed from a third party with the intention of buying the asset at a lower price at a later date. It is a way of making a profit when the price of a security falls.
This document is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Past performance is no guide to the future. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. Company examples are for illustrative purposes only and are not a recommendation to buy or sell. The views expressed are those of the Fund Manager at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority. No part of this document may be reproduced in any manner without the prior permission of JUTM or JAM.
The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen.Important Information: we do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.