1 October 2015

K.I.S.S.

Executive Summary

For the last month or so, global equity markets have been choppy as the markets try to find a bottom. We believe it is not productive for us to tinker with complicated models just to get a forecast when the correction is likely to end, or what would be the price of equities at the end of the year. Instead we prefer to focus on a range of critical data which would indicate whether or not the global economy is in bad shape and when the market is primed for its next move upwards. Our risk matrix signal continues to be RED and as such, we prefer to stay out of the markets for the time being with cash in hand ready to buy in when the signal changes. At this time, we do not see a large bear market occurring and take this correction as a blip within a longer term uptrend.

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At the end of August, our risk matrix triggered a reduction of risky positions across all our portfolios as it signalled a high stress environment in the financial markets. Since then, the market has brought investors on a trip similar to some of the stomach-churning rides at Universal Studios. The media, analysts, economists and even some CEOs, have proffered a range of theories on what is happening in the markets. However, depending on who you listen to, you are likely to end up being even more confused! We don’t want to theorize, forecast or even begin to explain why the market sold off, when the sell-off will end or what the level of the indices will be by the end of 2015. There is no need for complex modelling, or convoluted analysis to explain what is happening with the markets. We prefer to keep it simple and straightforward and just focus on the important data – whether we are facing a global recession and/or whether our signal is giving us the go ahead to be fully allocated to the market again. ​As our title suggests, lets “Keep It Simple, Silly” (K.I.S.S.)!​ KISS was a ​design principle noted by the U.S. Navy in 1960 which states that most systems work best if they are kept simple rather than made complicated.

No Global Recession Yet

The overall weight of fundamental and economic indicators currently do not signal that the global economy is facing a major recession. We are always worried about such an environment because recessionary bear markets are always drawn out affairs which cause big losses for investors. On the other hand, a correction within a secular bull is usually shorter, with the market resuming its uptrend within a few months after the sell-off. There is no doubt that some economies are now weak and these are mainly commodity producers within the Emerging Markets, with the larger developed economies showing signs of growth and stabilisation (Fig 1 ,2 & 3). However, given that there is still no confirmation of a recession, we maintain our default scenario that the current sell-off is healthy and should be taken in the context of the overall long term secular bull trend.

Fig 1: The NDR Global Recession Watch Report Which Is Not Signalling a Global Recession Yet

Fig 2: Leading And Coincident Economic Indicators Of The World’s Largest Economy (USA) Which Is Not Signalling A Slowdown At Present

Fig 3: Global Corrections When the US Was Not In Recession Had Always Been More Mild Such as in 1995, 1998 and 2012

Are We Near The Bottom?

Technically, there is no doubt that equity markets look weak (Fig 4). Chartists, especially the bears, have been tripping over themselves in glee, highlighting the amount of damage in the markets and foretelling the doom which is to come. Fundamental analysts on the other hand, paint a less gloomy picture highlighting that all is well with the world. Now, who do you listen to? We definitely do not want to cherry pick our data just to prove a point. We prefer to use a range of indicators, which feeds into our trusty Risk Matrix, to tell us whether the bottom is reached and whether the market can continue to sustain any upside. At present, our indicators do not show that any market upside can be sustained, so we should remain patiently on the side-lines with our cash in hand, ready to jump back into the market when the signals change (Fig 5).

Fig 4: Global Equity Momentum is Weak and We Would Like to See It In the Neutral/Bullish Zone In Addition to Other Signals before We Turn Positive On the Market

Fig 5: Market Breadth Has Only Just Crept Into Neutral. A Signal Into The Bullish Zone Will Signal The Likely Bottom Of the Market Correction.

Everything is China’s Fault

Commentators have been quick to bash China for causing the global slowdown and the equity market sell-off. To us, it really does not matter whether the Chinese are able to meet their 7.5% GDP growth number in 2015. We want to point out that the Chinese economy had doubled from $5 trillion in 2009 to $10.3 trillion by the end of 2014. Even if they grow at 5-6%, a 5% growth of a $10 trillion economy is the same as a 10% growth of a $5 trillion economy. It makes sense that China gradually slows down as it matures and restructures its economy to a more service-oriented one.

Actually, countries are more affected by what goes on in the US than in China, as shown by the higher correlation (green highlight) of manufacturing PMI (Fig 6). We have highlighted in our previous updates that the restructuring Chinese economy will affect some countries in the world. Prices of basic materials will be going down and these commodity producers will suffer. After ramping up on building mega cities and infrastructure, the government has realised that this method of growth is unsustainable in the long term. We also do not believe that the Shanghai A-share market caused contagion to the rest of the equity markets. In terms of impact, China makes up only just under 3% of the All-Country World Index. Again, what happens in the US has a greater bearing on the world than any other single country (Fig 7).

Fig 6: The Chinese Economy Is Big, But Does Not Overly Affect The World Unlike What People Make it Out To Be. The US Has A Greater Bearing On the World Economy.

Fig 7: China Makes Up Less Than 3% Market Cap In the MSCI All Country World Equity Index

Looking for Catalysts

Our macro view is still biased towards the developed markets of US, Japan and Europe as data remains supportive. What could make markets suddenly decide that the world is not such a bad place after all? Taking a look at global growth, it is interesting to note that the US consumer share of global growth is larger than even China (Fig 8)! Data out of the US suggests that the US consumer is doing fine, with a high possibility of upside surprise when you take into account personal spending, wage growth and consumer confidence. We would also turn positive on the market once our risk matrix flashes a buy and we see confirmation from other bullish signals (Fig 9) which is not present at this point in time. Stay tuned for updates.

Fig 8: The US Consumer Can Dig The World Out Of Its Slump

Fig 9: No Supportive Upside Signal Yet. We Want The Indicator to go Above 50%

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