Market outlooks diverging

Thu 05 Jul 2018

By Brian Dennehy

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Market commentary

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climb mountainOne way to analyse markets is Elliott Waves, as we explored within the Opportunity Knocks or Apocalypse Postponed report . On the face of it, it is a simple model.  Whether analysing 50 years or a few days, you will observe uptrends breaking down into 5 waves in total - 3 waves up and 2 waves down.  In the UK market (using the FTSE 100 index) the move up since late March looks incomplete, with a new high ahead, where we should expect this to unfold in the next month if this route map is correct.  If this is wrong, then a large correction is already underway from the mid-May peak.  The next month or two should provide clarity.
 
As we are mid-year it is also good to use this prism to consider global markets.  The US and Japan are in a very similar, and positive, position to the UK.
 
The German market looks to have broken down.  If wrong, this should be obvious and evidenced by rapid progress in the weeks ahead.  China looks like it could have another 6-8% of downside in the short term, at which point it might be worth re-visiting Chinese potential, taking a longer view.
 
You must assume this moderately positive outlook for the UK is constantly under threat, and have a contingency plan to protect your capital value, so far as possible.  You must not become complacent.  For example, on one scenario the British and German governments could fall in the months just ahead, and make Italy look like a beacon of stability.
 
The above is the context within which you are investing right now.  
 
It is also interesting to observe how smaller companies have behaved over the last 6 months.  We often say that small caps are the canary in the coal mine – if they begin to fail while the broader market continues up, you should expect the broader market to tumble quite soon.  
 
The current picture is a bit nuanced.  Year to date the FTSE Small Cap (ex IT) index is slightly underperforming the footsie (0.12% vs 1.68%), largely due to a sharper small cap fall in June.  In contrast, if you want to know how real small cap investors are doing, the average small cap unit trust fund is a decent surrogate, and that is up 5.24%.  The latter has also been achieved with very limited volatility – so no sense of selling or loss of confidence amongst smaller company investors.
 
Looking globally, the marked outperformance of small caps (as expressed by the average fund) has also persisted across Europe, US, and Japan, not just over 6 months, but over the last 10 years.  A positive back drop – just don’t get over-excited.
 
If you are feeling relaxed you probably haven’t been reading about President Trump.  His threats of a trade war are certainly unsettling markets, particularly in Asia and emerging markets (the latter aided and abetted by the perception of political and economic chaos across large parts of South America).
 
Looking at this month’s “What’s Hot?  What’s Not?”, Asia and emerging markets certainly dominate the dogs, with widespread worries over US rates rising, a stronger US dollar, trade wars, and rising oil prices.  One poor month does not kill off “The Asian Century” – but is this an opportunity, or a more prolonged slowdown?  One for us to revisit in the next month.
 
And much of what happens in the months ahead will depend on Trump.  Are trade war threats an opening shot in negotiations, to get other countries to engage brain and take him more seriously?  Or is it a contest for the benefit of US voters in the mid-term elections in November?   If the latter, by September we should see signs of a (well engineered?) “win” emerging, for domestic consumption.
 
On the face of it, Trump certainly isn’t unduly worrying the US market judging by that same “What’s Hot?” analysis, where the US dominates the top funds of the last month.  Digging deeper, what would you guess is the best performing US stock market sector since the peak at the end of January?
 
How about boring and safe utilities?  It’s early days, but in the past this has often occurred towards the end of an uptrend.  It is driven by those who believe the end is nigh, but still feel they have to be seen to be invested.
 
In summary, the next month should provide a bit more clarity on market direction, and the next 2-3 months should also clarify the political shenanigans – certainly in the US, probably in the UK, less likely in Italy.  
 
FURTHER READING
 

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