Still in the woods…

The market correction we are currently experiencing is not showing any imminent signs of abating. Significant market corrections can be self-fulfilling in nature, as fear leads to falling prices, which in turn can lead to further fear of further price falls. This vicious circle can happen even if the original fears are not well founded, as I believe to be the case now. It’s hard to predict how long the bearish conditions will last. The fact that valuations are still pretty high compared to historical averages suggests there is scope for prices to fall further. On the plus side, an environment of excessive pessimism seems to be building and I can see a few potential catalysts on the horizon that could lead to a sizeable rally in the not too distant future.

I made my scheduled trade last week, selling Accesso Technologies and buying Auto Trader.

Predictions about the macroeconomic situation don’t have a great deal of relevance to my strategy, but I have been thinking quite a bit about the risks. I’m still feeling bullish despite the negativity out there, but I’m no expert so there is a high chance I’m wrong. And if I am, at least I can read back through these posts and cringe at the hubris as we emerge from the rubble of the impending stock market Armageddon.

Brexit shenanigans have had a noticeable impact on the UK stock market last week. While the implications for the country as a whole are incredibly important, I have little concern that any of the possible outcomes (including ‘no deal’) would be that bad for my investments, particularly as very few of them are UK-centric. In fact, as my investments earn their revenues predominantly in dollars, I would stand to benefit considerably if the Pound plunged following a poorly received Brexit outcome. Unfortunately, I see a rising Pound (and falling Dollar) as more likely over the medium term, due to resolution of Brexit uncertainty and relenting US monetary policy. I’m not sure there is much I can do about this risk without compromising my strategy. Exchange rates are probably not worth worrying about too much anyway.

Fear about the future of the US economy seems a more important factor than Brexit in driving the market conditions we have seen over the past couple of months. The catalyst for the start of the recent turbulence was a crash in the US bond market in anticipation of the Fed pursuing a hawkish policy of interest rate hikes. Why this should harm stocks as it has is rather less obvious, particularly given the US economy seems to be doing so well. Interest rates aren’t at a level to concern borrowers. In previous periods where the Fed has gradually tightened monetary policy as the economy boomed, the stock market has tended to do well. So what’s up now?

To start with, stock market valuations are high when looked at from certain perspectives, like the CAPE ratio. I don’t really agree with these perspectives but enough investors do to make the market pretty twitchy in responding to macroeconomic fears. While valuations have actually fallen considerably this year due to rapid corporate profit growth, next year will no longer benefit from the tax cuts.

I believe many investors are starting to see a recession as imminent. There are a few reasons to fear this: negative impact from escalation in the trade war with China, a tight labour market and the spectre of inflation, the possibility of the Fed screwing things up by raising interest rates too fast, or simply because it’s been a long time since the last recession. A recession will almost certainly happen at some point and some of these reasons may be behind it. However, they all seem fairly speculative to me at the moment with the US economy being in such rude health. There isn’t really any sign of the economy slowing or inflation getting out of hand. I don’t see why the current business cycle would not go on for a few more years yet. There are always macroeconomic fears around. The good news is that they can provide the fuel for the next rally – cash balances are rising. Resolution of some of these fears could spark a big rally.

I sold out of Accesso Technologies at the beginning of last week for a substantial 30% loss, after a dramatic fall from its highs of almost 50%. It was a fairly large position, so this was my biggest loss yet in absolute terms. There doesn’t seem to have been much good reason behind the recent fall, though the recent trading update was a little disappointing and it has been the target of some shorting due to its high valuation. While I think its valuation may have been justified given its likely growth over the coming years, in hindsight I feel I had excessive confidence in Accesso. Its main weakness is that it hasn’t convincingly yet demonstrated that it can achieve high profitability. This does create uncertainty and means the quality of the business is probably not as high as I gave it credit for. The one positive note is that the price has continued to fall since my sale and now looks downright cheap. However, I will wait for it to stabilise or positive news before reinvesting.

I bought back Auto Trader, after its recent results were ahead of expectations. Auto Trader seems to be making good progress despite headwinds in the auto sector and is on a very reasonable valuation. I held Auto Trader recently and wrote about it here.

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