Investment Clock insights

From panic to complacency?

Trevor Greetham

1 March 2019

Global growth slowed over 2018 and inflation rose, moving our Investment Clock model into the Stagflation phase of the business cycle. As a result we cut the equity positions in the multi asset funds we manage to neutral by late summer and were able to buy stocks on weakness in Q4 2018 when markets were prematurely panicking about the risks of a US recession.

It pays to buy when others are fearful. Our investor sentiment indicator registered one of its ten most extreme contrarian buy signals (Table 1) in late December during what we label as the “Trump Slump” – a brutal sell off exacerbated by a Christmas twitter storm of threats of a trade war with China and criticism of the independent US Federal Reserve (Fed) for raising interest rates.

Table 1: The Top 10 most extreme weekly sentiment readings since 1990

Source: RLAM as at 28/02/2019

Note: The RLAM Composite Sentiment Indicator is a normalised combination of indicators related to market volatility, private investor sentiment and US director dealing in shares in their own companies.

Stock markets have risen strongly since the year end with the Dow Jones index enjoying its longest winning streak of positive weekly gains in twenty five years. Our sentiment indicator is now registering its highest reading since January 2018 (Chart 1), suggesting that investors are now a bit too complacent about growth. In particular, US company directors have swung from buying the shares in their own companies during Q4 to selling them and they tend to get it right.

Chart 1: The highest sentiment reading since January 2018

Source: Thomson Reuters Datastream as at 22/02/2019

We moved our equity exposure back down to a more neutral level during the rally. We are seeing additional stimulus in China, the Fed has stopped raising interest rates and President Trump appears to have backed down on threats of new tariffs on China but markets appear to be priced for perfection and it’s too soon to say an upturn in growth is underway. Our base case is that growth surprises positively against muted expectations in 2019. Stock markets should go higher but we would prefer to wait for a dip – or a more convincing improvement in economic data – before adding significantly to our equity exposure.

Longer term the outlook is getting cloudier. The US housing market is cooling off and that doesn’t bode well. A drop in home builder sentiment is a good one to two year lead indicator of a rise in unemployment (Chart 2). If growth does firm up later in the year, we believe US interest rates are likely to rise further, putting more downward pressure on housing and raising the risk of a full blown recession in 2020.

Volatility is here to stay and it pays to have an active strategy that can take advantage of it.

Chart 2: Home builder sentiment as a 6 quarter lead indicator for the US unemployment rate (shown inverted)

Source: Thomson Reuters Datastream as at 15/02/2019

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.