A Fearful Sell-off Indeed. Why and What to Do?

The recent sell-off shows the fear in the markets which relates to a poorer growth outlook for the world in general and a subsequent downward repricing of shares worldwide. But has the prospect of slow growth already been fairly discounted in share prices? And how should one position one’s portfolio in the current environment?

Few would dispute that the global economic system is compromised.  The hangover from the great credit boom has still not been eradicated.  Now, the one country, which at the margin provided the world with substantial growing demand, China, is facing its own conflicts.

Having spewed out credit and capital projects to offset the weak demand emanating from the collapse of activity in the West in 2008, China is now experiencing the inevitable adjustment in the components of its growth – a need for more personal consumption and less investment.

This adjustment is being accompanied by capital leaving the country and a loss of foreign exchange reserves as the government tries to hold the exchange rate.  This is likely to be futile and it would serve better for the level of intervention to be minimal and the exchange rate to find a new lower level¹.  Implicitly there is a tightening of credit happening in China.

We believe it is highly likely that the Chinese authorities will energetically adopt policies to alleviate these pressures with the banks being allowed more latitude to lend and other initiatives taken to promote growth².

For all these woes, there is evidence that the recovery in the West is becoming more entrenched.  The desire to raise the cost of money, in a world that for the moment is awash with cheap energy and commodities, may be reduced.

So the fear in the markets relates to a poorer growth outlook for the world in general and a subsequent downward repricing of shares worldwide.

This may not matter because markets are dynamic and as we have just witnessed, risk gets repriced exceedingly swiftly.  The question is then whether markets have now reached a level where the prospect of slow growth, and associated weak prices in commodities (oil, metals and agricultural produce), is fairly discounted in share prices.

We believe that this is the case in many instances.  However, it does not rule out the possibility of a market overshoot.

Comforting is the fact that when one can buy powerfully entrenched businesses on valuations that are generally in line with their 20 year averages, one normally makes good returns in subsequent years.

Our funds have been raising cash in the face of what were high valuations and are reasonably well-placed to take advantage of panic-stricken mispricings.

With the prospect of interest rates remaining low, equities remain a valuable component of one’s portfolio.

 

[1] The RMB has been far stronger than the US dollar since 2005 – rising in value from 8.09, a 23% increase.

[2] On account of the banks having 18.5% of their deposits locked-away with the Central Banks – unlike QE we saw in the West, there is no need for QE etc – at this stage.

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