The only thing we have to fear..

“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

“A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

“You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

“Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.”

–        Warren Buffett, ‘Buy American. I Am.’ Op-ed in the New York Times, October 17, 2008.


The great biologist E.O. Wilson once observed that

“The real problem of humanity is the following: we have paleolithic emotions; medieval institutions; and god-like technology. And it is terrifically dangerous, and it is now approaching a point of crisis overall.”

In few arenas are our mental shortcomings thrown into more stark relief than in the investment markets. Our brains evolved ‘fight or flight’ mechanisms to enable us to recognise potential predators in the wild. They have not yet had the evolutionary time to help us respond to threats – real or perceived – in the economy, bond or stock markets.

Notwithstanding Warren Buffett’s reassuring counsel cited above, there are clearly reasons to be less than cheerful about a variety of financial hazards today. The slow motion train wreck that is Greece just happens to be one of them. Any rational investor would probably also include the threat of higher US rates; a slowdown in China; general valuations.. But perhaps the loudest klaxon currently blaring in the markets is that of price action itself. Price volatility across numerous markets is starting to explode.


Fund manager Lee Robinson of Altana Wealth in a note to clients writes as follows:


“I have seen many exciting moves in my trading career and as a keen reader of market history, I have read about many others. An oil price move of 50% in six months is big but not a stand-out move. But I would point out the following as memorable: the US stock market had six Hindenburg Omens in six of eight trading days in December and between early December and January over 40% of trading days exhibited Hindenburg Omens. To my knowledge neither has happened before. A simple way to think about Hindenburg Omens is basically when over 2.2% of all stocks are making new highs and new lows on the same day, which implies the underlying market is pulling in separate directions. Remember that almost all stock market crashes have been preceded by confirmed Hindenberg Omens, although they can occur without a crash subsequently happening. They are rare events normally.


This heightened volatility is not a characteristic just of stock markets in isolation. As Lee points out,


“Silver moved from $16.5 to $14.5 back to $16.5 in one trading session in December. That is a 25% round trip in a commodity which has been priced for thousands of years and should not therefore be behaving in such a volatile fashion ordinarily. The Ruble was even more volatile. One year ago it was at 32 to $1 yet in one day it moved from 58 to 80 back to 68 – a round trip of 32. Russia is a G8 nation with 140 million people. Now of course we have the Swiss Bank move and competitive devaluations in Turkey, Belarus and Kazakhstan. We expect the other former Communist states to shortly follow leading to further euro weakness. Finally, the Baltic Dry [freight] is an index that is hard to manipulate; despite money printing it heads towards new lows; and companies such as UPS complain about poor Thanksgiving and Christmas sales despite a strong dollar and a low oil price. 2015 is going to be a volatile year. Again we implore clients to think carefully about their currency and counterparty exposures.”


In recent weeks we’ve highlighted the aberrant price and yield volatility of longer dated German government bonds. Since these instruments represent something close to the ‘risk-free’ rate for the euro zone, the fact that their prices are convulsing like someone in an electric chair hardly bodes well for future price stability across other capital markets. It’s not fair just to blame Greece – how about the central banks that drove interest rates down to zero, effectively forcing investors into higher risk markets ?


The markets cocktail of 2015 is a strong one, and whatever decision you ultimately make involves having to take a sip or two. Bond prices are high (but we think unlikely to go meaningfully higher – there’s certainly insufficient value there for us). Most stock market levels are high (but may easily go higher). Currency volatility is high. Commodity price volatility is high. Even deciding to hoard cash is a decision to embrace an unusual level of risk these days – as Greece may confirm in due course. For us, the sensible response is two-fold. One: diversify across asset classes to an unusual extent as preparation for whatever future shocks may come. Two: avoid the credit markets wherever possible, and favour instead high quality equity – or equity managers – offering the closest  thing to  a genuine margin of safety. To our way of thinking, nothing else makes any sense.

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