Page 41 - DIY Investor Magazine - May 2019

GOOD NEWS, BAD NEWS AND WALLS OF WORRY
The MSCI All Country World Index is up 250% since
the financial crisis; but was there ever a cycle in which investors were more skeptical about the market’s upward momentum, where stock valuations had to climb so many ‘walls of worry’? asks Sherri Payne
The wall of worry is associated with a maturing cycle, when there is still potential upside in stocks, but cracks in underlying fundamentals combined with rising volatility make late-cycle investing such a challenge; this cycle is maturing with an especially high and slippery wall and investors climbing it will need to work hard to maintain balance and vigilance.
After a dramatic sell-off at the end of 2018, stock markets rebounded briskly, but as Joe Amato observed, when investors adjust to softer economic data against a background of thin market liquidity, sharp upward moves can be just as common as sharp downward moves and not mark an ‘all clear’ signal; underlying economic data and market risks have worsened as equities rallied.
Europe’s performance continues to be poor; Italy is
in technical recession and following mixed survey sentiment and PMI results it was revealed that Germany avoided the same fate by the narrowest of margins.
Global stock markets hit a six-month high this morning (April 15th) on optimism that America and China could reach a trade truce; however, the White House has received a report into whether imported autos could pose a security risk under Section 232 of the U.S. Trade Expansion Act, opening the potential for tariffs that could cause a widely reverberating growth shock to Japanese and German industries already suffering from a crash in diesel sales, and for Europe as a whole.
To find the reason why investors are now climbing this wall of worry rather than tumbling, look to the major central banks.
The Fed has been noticeably more dovish, the ECB confirmed that it was discussing a new round of Targeted Longer-Term Refinancing Operations and the governor
of the Bank of Japan hinted that easing tools were at the ready. In China, strong credit growth may be a sign that stimulus is taking hold, leading to improving PMIs down the line.
Central bank adjustments will be an important contributor to a soft landing, but let’s not forget that they are adjusting in response to substantial underlying risks.
A cycle full of walls of worry is likely to mature with a
big wall of worry; in the late stages of a cycle defined
by quantitative easing the gold rally encapsulates the dilemma - does it predict lower-for-longer interest rates that will extend the cycle, or it forebode a premature end to that cycle? A prudent late-cycle investor considers both possibilities.
A soft landing appears achievable, but careful portfolio diversification remains important, which includes maintaining diversification by trimming equity and credit exposures when markets rally; this not only helps hedge against the soft-landing view being wrong, it also helps to mitigate the downside when volatility strikes.
Well-diversified investors are less likely to have to
sell during periods of volatility when markets may be illiquid and are therefore better able to take advantage by buying assets that stand to do well should the cycle extend, but at lower valuations that help mitigate downside exposure.
41 DIY Investor Magazine | May 2019