Communication breakdown

The US central bank changed tack so fast in 2019 that you could hear the thunderclap. Rathbone Global Opportunities Fund manager James Thomson warns that investors shouldn’t follow suit. 

10 April 2019

After bungling its December press conference, the US Federal Reserve (Fed) backtracked so fast in early 2019 it almost gave the market whiplash. But that doesn’t mean investors should drastically change course as well.

Back in December, the economy was rosy, the stock market was in the toilet, and the Fed was going to hike interest rates twice in 2019. That wasn’t all. The Fed was also on “autopilot”, running down the $4 trillion pile of bonds and other debts it bought during quantitative easing. This is another way to ‘tighten’ monetary policy – essentially making it more expensive to borrow money, therefore slowing the growth of money in the economy, reducing inflation and also dampening GDP expansion.

It soon became clear to the Fed that it was being slightly too gung-ho, with economic growth decelerating and stock markets continuing to quiver. So the central bank announced it would soon be finished with its tightening efforts – in fact, it wouldn’t be raising interest rates for the whole of 2019 and possibly 2020 as well. Equities roared back in response, yet the market still feels hesitant. Some investors worry that the Fed must have some as-yet-secret, nuclear information about the economy to make it reverse course so suddenly and so overwhelmingly. Succinctly, many investors think the current rally is fake – although I’m not one of them.

What are the lessons to learn from all this? Perhaps the main one is that the Fed has been terrible at telling investors what’s happening with monetary policy. The Fed has flip-flopped so often that I think it’s fairly probable they it will do so again. Another lesson: it’s exceedingly difficult to time markets, to determine what is a short-lived pullback and what is a bad funk that’s going to hang round for much longer.

Many investors seem to be waiting for earnings growth to start ratchetting up again after a year of steady deceleration – from some very high growth numbers, I’ll add. But investing doesn’t work like that. By the time something is a sure thing, the price will have moved to reflect it. As the head strategist at JPMorgan says, “Crucially, equities never wait for earnings in order to recover.” Historically, equity prices lead earnings by up to 10 months. That’s why we’ve seen so many stocks rally over the last month or so, even as analysts are cutting their earnings forecasts. 

It’s been a busy year, with plenty of ups, downs, opportunities and concerns. President Donald Trump’s substantial tax-cuts gave companies one-off gains that went through company financials like a hippo in a snake’s belly. That’s before you factor in large swings in currencies and commodities as well. Take oil: the price of crude is about $68 today. It ended 2018 at just $50.50; just three months earlier it was $86. Oil and taxes are pretty pivotal costs for companies. As these gyrations start to fall out of company accounting, investors will find it difficult to determine what is a return to business as usual and what’s a slow-down in performance.

Many investors looking at this situation appear to be waiting to gather more evidence before coming back into the market. We would caution against trying to “time” the market like this. To show how difficult and punitive it can be to enter the market at just the right time, just look at this chart.

It shows that, over 50 years, if you missed the 10 best days while investing (and the compounding benefits thereafter) your return was halved. Best to add small amounts regularly to smooth out your risk and improve your returns, rather than trying to be a hero.

That’s what I’ve been doing with my fund. As markets drop back I’ve been adding to existing holdings and buying new companies at prices that we like. It’s very possible that my timing will be wrong in the short term. Another possibility is that a recession really is looming just over the horizon. The point is, I can’t know. Nobody can. Predicting a recession is like predicting a volcanic eruption. You can note rising pressures and a bit of smoke, but you can be waiting a long, long time before something actually happens.

Instead, it’s best to focus on the companies you own and those you’d like to own. Watch for weaknesses and opportunities, ensuring you’re comfortable with their prices. Only invest in something you think will be able to survive a downturn and thrive over the next 10 years or more.  That’s what I’ve been doing for nearly 15 years.

James Thomson, Fund Manager           

Rathbone Global Opportunities Fund