Mark Draper

Mark Draper

Tuesday, 13 February 2018 09:08

5 Lessons from the market correction


Mark Draper (GEM Capital) recently contributed to an article that was published in the Weekend Financial Review in February - titled "5 Lessons from the correction".

We have permission from Fairfax Media to bring you the article on our website.


Thank goodness the week is over. The S&P 500 index in the United States suffered its two biggest points falls in history, while the local benchmark plummeted nearly 5 per cent in two days and then fell 52 points on Friday.

The falls seemed all the more dramatic because they followed such a long period of market bliss.

In the midst of the mayhem, it was easy to forget that the decline followed huge gains in stock prices last year.

But it is worth remembering just that. The S&P/ASX 200 rose from 5733 points to 6065 in 2017 and is now sitting at 5838. Its US equivalent surged 25 per cent last year, and on Thursday night closed at 23,860 – still 21 per cent higher than at the start of last year. So equity investors haven't done too badly.

It is also worth remembering what caused the crash and how short term – or long term – those causes might be.

The immediate catalyst was US jobs figures, which showed wages growing faster than expected and weekly jobless claims hitting a 45-year low, raising the prospect of higher inflation and interest rates.

Analysts also pointed to a deteriorating US federal budget as a secondary factor.

But some economists argue the wages data contains anomalies and could well be revised next month. Some also suspect the jobless figures might be overstated because data for several states were estimated.

Further, one of the presidents of the Federal Reserve, James Bullard, cautioned against drawing parallels between good news on the labour market front and higher inflation. The relationship had broken down in recent years and may now be non-existent, Bullard said in a speech.

It also appears that algorithmic trading programs exacerbated the sharemarket falls in the US, at least in the early part of the week. Algorithms are set up to react to certain conditions. A fall of, say, 5 per cent in the index, may trigger the machine to sell.

Reports out of the US suggest that many of the algorithms that sold equities on Monday were "selling short". In other words, they sold stocks to buy them back cheaper at a later date.

Still, this is not to say that stockmarkets – which have been turbo-charged by ultra cheap money since the global financial crisis – are off the hook. Experts say investors would be wise to learn the lessons that have been offered up this week. Here are five of them.

1. Make sure you are not a forced seller

Regardless of where financial markets are in the cycle, investors need to ensure they are not in a position where they have to sell stocks – which can happen if equity markets remain in the doldrums for a couple of years.

"Not being a forced seller and having cash set aside to get through difficult market periods is probably the best advice I can give," says Mark Draper of GEM Capital in Adelaide.

Being forced to sell can arise for several reasons.

Retirees may need to sell assets to finance their lifestyle, savers may be parking money in the sharemarket to buy property or investors may have borrowed to buy shares and face demands for loans to be repaid.

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Monday, 12 February 2018 01:11

The real world, markets and volatility

As most of you will have noticed, global share markets have been very turbulent, and sharply down this month.

Since global markets peaked on January 23rd they were down 4%, in Australian dollars, by this morning Sydney time. Further weakness, especially in Japan today, has pushed them down about 1% more over the Australian trading day.

Figure 1 – Global markets in Australian dollars (NDUEACWF in AUD) for last 12 months.

Source: Bloomberg, Team Analysis

Our view is that this does NOT mark the end to the bull market we have seen since we launched the Morphic Global Opportunities Fund in 2012. In consequence, we remain fully invested and have increased our holdings in selected over-sold stocks.

Our confidence springs from three factors:

  • Strength in the underlying global economy
  • Low contagion risk to the financial system or the real economy
  • Technical elements to the sell-off


Concluding our recent half-yearly report to our investors, published in mid-January, we said:

… when the real economy (as opposed to the financial economy that markets operate in) gets momentum, that momentum is hard to break – like a supertanker.

Risks? A recession in 2018 remains unlikely. If we were to nominate a risk, it is that the financial economy fails to adjust in an orderly manner to reflect the changed (stronger) real economy. 

This could cause a bond market rout as investors get excessively concerned about inflation, which contaminates other assets. But we see this as unlikely at this stage – and it would probably be a mistake to position for it before late 2018.

Since then, economic data from most major economies has surprised positively. In the US, for example on Friday, December employment data was much better than expected and yesterday the broadest measure of business confidence, the so-called Non-Manufacturing Purchasing Manager Index, reached its highest level in a decade. Similarly strong signals of a sustainable growth pick-up can be seen in Japan, Europe, and most major emerging markets.

Although corporate earnings don’t always go hand in hand with economic trends, in 2018 we are seeing a simultaneous pick-up in earnings projections for the year ahead after 2017 that generally proved better than expected.

The risk of all this, as we alluded to in our half-yearly report was that global bond markets would over-estimate inflation pressures. A bond sell-off, which is reflected in sustained higher yields, can force a repricing of equities, as investors push down their view as to ‘fair market’ price-earnings multiples.

The key word here is ‘sustained’. In our view, the market is already (and correctly) having second thoughts about inflation risks. US 10 year treasury bonds where the yield peaked at just under 2.88% on Friday, from 2.43% on January 1 are now back to 2.69%.

Figure 2 –  US 10 year treasury yields, Year to Date

Source: Bloomberg, Team Analysis


Most investors are hyper-aware of the most recent market sell-off. In this context, it is not unnatural for people to worry about a repeat of the global financial crisis of 2007-2009.

A key feature of that event was the way a doubling in interest rates over four years led to the unwinding of excess valuation in a single asset, US housing, exposing systematic weakness in global financial institutions. This caused a collapse in credit availability feeding back into the real economy, before opening up secondary fissures such as the European peripheral debt crisis.

Today banks globally are much better capitalised. Strict limits on the kinds of risk they can take also create a powerful ring-fence against this kind of negative feedback loops. Reflecting this, global liquidity remains ample.


The steadiness of the bull market has pushed a small set of investors into dangerous assets. In our half-yearly report, we referred to the crazy bubble surrounding crypto-currencies like Bitcoin. Since then Bitcoin has halved.

A less remarked upon high-risk activity was investors betting that market volatility would stay low, and consistently prove lower at the end of each month than feared at its beginning. As money poured into complex funds that replicate this and similar strategies, the markets ability to absorb a change of sentiment has proven very limited.

This has resulted in a much greater surge in the so-called Volatility, or VIX index, (also known, more poetically as the “fear” index) that can be justified by underlying market movements.

Figure 3 – VIX Index over the last five years

Source: Bloomberg, Team Analysis

We believe the limited liquidity of these fairly obscure markets will result in a ‘cleansing’ of this kind of activity from the system. As volatility returns to more normal levels, as it nearly always does, stock market stability and recovery will follow.


Sometimes the hardest – but the safest – thing to do is nothing. Until we lose faith in the points above, we are not going to engage in panic liquidation – as some of the complex funds we refer to above are doing.

When the dust settles, as long as global financial institutions stay robust, the prospects of impacts on the fundamental economy are limited. Not only will stocks bounce back, but we expect them to go to new highs, supported by the strong economic and earnings background. A less skittish bond market, may settle at higher levels, but not so high as to unravel global growth, corporate earnings or investor views as to fair value.

Jack Lowenstein and Chad Slater (Morphic Asset Management)



We are planning to add Montgomery Investment Management to our recommended list of investments early in 2018.  In particular we are impressed by their Global Investment team who have had an impressive track record since the fund began a few years ago.

The Montgomery Global Fund is listing on the ASX on 20th December 2017 and is a portfolio of high quality global companies aiming to pay a half yearly income distribution of 4.5%pa.  We will have further details on this fund in the new year.

In the meantime, here is a sample of how Montgomery Investment Management think about investing in a comprehensive report that makes excellent reading over the Festive Season.  The articles are written by the investment team at Montgomery Investment Management, rather than a marketing spin doctor and are very informative. 


To read the report simply click on the picture of the report below.

Some of the content in this edition include:

1. How the changes in the $AUD impact global facing businesses

2. Why do Montgomery's own Facebook

3. Should you own Wesfarmers?

And many more articles.


Thursday, 07 December 2017 10:24

Reversal of Money Printing (QE)

Dom Guiliano (Magellan)

Thursday, 07 December 2017 10:01

Bubbles, Busts and Bitcoin

Shane Oliver - Chief Economist AMP


The surge in bitcoin has attracted much interest. Over the last five years, it has soared from $US12 to over $US8000; this year it’s up 760%. Its enthusiasts see it as the currency of the future and increasingly as a way to instant riches with rapid price gains only reinforcing this view. An alternative view is that it is just another in a long string of bubbles in investment markets.

Nobel Economics Laureates Daniel Kahneman, Robert Shiller and Richard Thaler and many others shown that investors and hence investment markets can be far from rational and this along with crowd psychology can drive asset prices far from fundamentally justified levels. This note provides a refresher on the psychology of investing before returning to look at bitcoin.

Irrational man and the madness of crowds

Numerous studies show people suffer from lapses of logic. In particular, they:

  • Tend to down-play uncertainty and project the current state of the world into the future – eg, resulting in a tendency to assume recent investment returns will continue;
  • Give more weight to recent spectacular or personal experiences in assessing probabilities. This results in an emotional involvement with an investment – if it’s been winning, an investor is likely to expect it to keep doing so;
  • Tend to focus on occurrences that draw attention to themselves such as stocks or asset classes that have risen sharply or fallen sharply in value;
  • Tend to see things as obvious in hindsight – driving the illusion the world is predictable resulting in overconfidence;
  • Tend to be overly conservative in adjusting expectations to new information – explaining why bubbles and crashes normally unfold over long periods; and
  • Tend to ignore information conflicting with past decisions.

This is magnified and reinforced if many make the same lapses of logic at the same time giving rise to “crowd psychology”. Collective behaviour can arise if several things are present:

  • A means where behaviour can be contagious – mass communication with the proliferation of electronic media are perfect examples of this as more than ever investors get their information from the same sources;
  • Pressure for conformity – interaction with friends, social media, performance comparisons, fear of missing out, etc;
  • A precipitating event or displacement which motivates a general investment belief – the IT revolution of the late 1990s or the rapid industrialisation of China which led to talk of new eras are examples upon which were built general believes that particular investments will only go up.

Bubbles and busts

The combination of lapses of logic by individuals and their magnification by crowds goes a long way to explaining why speculative surges in asset prices develop (usually after some good news) and how they feed on themselves (as individuals project recent price gains into the future, exercise “wishful thinking” and receive positive feedback via the media). Of course this also explains how the whole process can go into reverse once buying is exhausted, often triggered by bad news.

The chart below shows how investor psychology develops through a market cycle. When times are good, investors move from optimism to excitement, and eventually euphoria as an asset’s price moves higher and higher. So by the time the market tops out, investors are maximum bullish and fully invested, often with no one left to buy. This ultimately sets the scene for a bit of bad news to push prices lower. As selling intensifies and prices fall further, investor emotion goes from anxiety to fear and eventually depression. By the time the market bottoms out, investors are maximum bearish and out of the market. This sets the scene for the market to start rising as it only requires a bit of good news to bring back buying.

The roller coaster of investor emotion

Source: Russell Investments, AMP Capital

This pattern has been repeated over the years. Recent examples on a globally-significant basis have been the Japanese bubble and bust of 1980s/early 1990s, the “Asian miracle” boom and bust of the 1990s, the tech boom and bust of the late 1990s/early 2000s, the US housing and credit-related boom and bust of last decade and the commodity boom and bust of late last decade into this decade. History may not repeat but rhymes and tells us asset price bubbles & busts are normal.

Where are we now?

Our assessment in terms of global share markets is that we are still around “optimism”. Investor sentiment is well up from its lows last year and some short-term measures are a bit high, warning of a correction (particularly for the direction-setting US share market) but we are not seeing the “euphoria” seen at market tops. The proportion of Australians nominating shares as the “wisest place for savings” remains very low at 8.9%.

But what about bitcoin? Is it a bubble?

Crypto currencies led by bitcoin and their blockchain technology seem to hold much promise. The blockchain basically means that transactions are verified and recorded in a public ledger (which is the blockchain) by a network of nodes (or databases) on the internet. Because each node stores its own copy, there is no need for a trusted central authority. Bitcoin is also anonymous with funds just tied to bitcoin addresses. Designed to work as a currency, bitcoin therefore has much to offer as a low-cost medium of exchange with international currency transfers costing a fraction of what, say, a bank may charge.

However, bitcoin’s price in US dollars has risen exponentially in value in recent times as the enthusiasm about its replacement for paper currency and many other things has seen investors pile in with rapid price gains and increasing media attention reinforcing perceptions that it’s a way to instant riches.

However, there are serious grounds for caution. First, because bitcoin produces no income and so has no yield, it’s impossible to value and unlike gold you can’t even touch it. This could mean that it could go to $100,000 but may only be worth $100.

Second, while the supply of bitcoins is limited to 21 million by around 2140, lots of competition is popping up in the form of other crypto currencies. In fact, there is now over 1000 of them. A rising supply of such currencies will push their price down.

Third, governments are unlikely to give up their monopoly on legal tender (because of the “seigniorage” or profit it yields) and ordinary members of the public may not fully embrace crypto currencies unless they have government backing. In fact, many governments and central banks are already looking at establishing their own crypto currencies.

Regulators are likely to crack down on it over time given its use for money laundering and unregulated money raising. China has moved quickly on this front. Monetary authorities are also likely to be wary of the potential for monetary and financial instability that lots of alternative currencies pose.

Fourth, while bitcoin may perform well as a medium of exchange it does not perform well as a store of value, which is another criteria for money. It has had numerous large 20% plus setbacks in value (five this year!) meaning huge loses if someone transfers funds into bitcoin for a transaction – say to buy a house or a foreign investment – but it collapses in value before the transaction completes.

Finally, and related to this, it has all the hallmarks of a classic bubble as described earlier in this note. In short, a positive fundamental development (or “displacement”) in terms of a high tech replacement for paper currency, self-reinforcing price gains that are being accentuated by social media excitement, all convincing enthusiasts that the only way is up. Its price now looks very bubbly, particularly compared to past asset bubbles (see the next chart – note bitcoin has to have its own axis!).

Because bitcoin is impossible to value, it could keep going up for a long way yet as more gullible investors are sucked in on the belief that they are on the way to unlimited riches and those who don’t believe them just “don’t get it” (just like a previous generation said to “dot com” sceptics). Maybe it’s just something each new generation of young investors has to go through – based on a thought that there is some way to instant riches and that their parents are just too square to believe it.

Source: Thomson Reuters, Bloomberg, AMP Capital

But the more it goes up, the greater the risk of a crash. I also still struggle to fully understand how it works and one big lesson from the Global Financial Crisis is that if you don’t fully understand something, you shouldn’t invest.

At this stage, a crash in bitcoin is a long way from being able to crash the economy because unlike previous manias (Japan, Asian bubble, Nasdaq, US housing in the chart above) it does not have major linkages to the economy (eg it’s not associated with overinvestment in the economy like in tech or US housing, it is not used enough to threaten the global financial system and not enough people are exposed to it such that a bust will have major negative wealth effects or losses for banks).

However, the risks would grow if more and more “investors” are sucked in – with banks ending up with a heavy exposure if, say, heavy gearing was involved. At this stage, I think it’s unlikely that will occur for the simple reason that being just an alternative currency and means of payment won’t inspire the same level of enthusiasm that, say, tech stocks did in the late 1990s (where there was a real revolution going on).

That said, it’s dangerous to say it can’t happen. There was very little underpinning the Dutch tulip mania and it went for longer than many thought. So it’s worth keeping an eye on. But as an investor I’m staying away from bitcoin.

What does this mean for investors?

There are several implications for investors.

  1. The first thing investors need to do is recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of other investors.
  2. Investors need to recognise their own emotional capabilities. In other words, investors must be aware of how they are influenced by lapses in their own logic and crowd influences.
  3. To help guard against this, investors ought to choose an investment strategy which can withstand inevitable crises & remain consistent with their objectives and risk tolerance.
  4. If an investor is tempted to trade they should do so on a contrarian basis. Buy when the crowd is bearish, sell when it is bullish. But also recognise contrarian investing is not fool-proof – just because the crowd looks irrationally bullish (or bearish) doesn’t mean it can’t get more so.
  5. Finally, while crypto currencies and blockchain technology may have a lot to offer bitcoin’s price is very bubbly.
Thursday, 07 December 2017 09:55

Outlook for 2018

Gerard Minack (investor)

Thursday, 07 December 2017 09:52

Gerard Minack - what's in store for 2018

Well known investor Gerard Minack, who also sits on the board of Morphic Asset Management recently produced this video on this thoughts for investment markets for 2018.

This video was produced for the Morphic Asset Management roadshow and has been reproduced with their permission.


By Geoff Wood (Morphic Asset Management)



















Humans tend to fear spectacular, but unlikely events. This is the proposition that Bruce Schneir makes in his book “Beyond Fear”.For example, European tourism has been significantly impacted by much talked about terrorist attacks despite the extremely low probabilities of something occurring to any individual. With the anniversary of October 1987 recently, it was remarked that “the week after the crash people started worrying about a crash”. The more recent an event’s occurrence is to you, the more likely you are to think that event is going to happen (when in fact it’s actually a lot less likely).


What does this look like? Overall we tend to underestimate threats that creep up on us. Humans are ill-prepared to deal with risks that don’t produce immediate negative consequences, like eating a cupcake or smoking cigarettes. For example, surveys show more people fear dying from cancer than they fear heart disease.

As markets push on globally to new highs and talk of bubbles emerges, I thought it would be timely to take a look back at the last century to see what the world looked like when markets were making all-time highs before a big correction.

In the below table (Figure 1), we identify seven major highs in the US S&P 500 stock market. The criteria for identifying a “major high” was twofold:

  1. the market was making highs; and
  2. it was followed by a market fall of at least 25% in the following 18 months. Why 25%? Because falls of 15-20% are relatively common in a bull market. The ongoing bull market since 2009 has already had two of these episodes.

The first thing that should strike a reader is how rare these events are: seven times in 90 years so roughly every 12 years. So in one’s investing life (~40 years), there should be on average 3 “events”. For all the talk of fearing crashes every year, one should not bank on them too often – meaning the old saying “time in the market is more important than timing the market” has a ring of truth to it.

Importantly though, note that they are not evenly spread at 12-year intervals as we observe a clustering around the 1960s and the early 2000s. For whatever reason, these events have tended to “clump”.


Source:Bloomberg, Team Analysis


I then looked into a selection of market and macroeconomic data points to see what they were indicating at these market tops (Figure 2). Some statistics include:

  • the level of unemployment;
  • the Purchasing Managers’ Index (PMI) levels, which are surveys quantifying manufacturers order books;
  • consumer surveys to gauge their optimism;
  • and the Federal Reserve’s level of interest rate and perhaps more importantly how much had it changed coming into the high.

The first thing to note, which is to be expected, is there is not one consistent signal across all the outcomes. I say if there was consistency, markets would already be using the indicator! But a few pertinent points do jump out:

  • stock market highs before a crash have occurred two thirds of the time when unemployment was below 5%;
  • in most cases, the Fed has been hiking;
  • consumer expectations have been elevated but falling;
  • and PMI surveys of future expectations have been mixed.

However, the last two market highs were made with confidence starting to wane, while for prior occurrences it was strong and strengthening.


Source: Bloomberg, Team Analysis


S&P valuations have had a wide range from 10 to 25x price/earnings (P/E) over the last century, reflective of the wide range of deflation, inflation, reflation and stagflation that markets have lived through.

We find that market tops in the S&P have tended to occur when the market was expensive – but not eye wateringly so – at around 20x. The 2000 dot com top was an exception with the market trading closer to 30x.

In most cases, P/E’s are expanding into market tops, which is a sign of continued confidence about the future (Figure 3).


Source: Bloomberg, Team Analysis


Are stocks losing or gaining momentum into the peak?

Figure 4 looks at the path coming into the peak. Prices have generally risen 20% or more in the 18 months preceding the high and are 30% above any lows in that same period. The range can vary hugely with “blow-off” moves off 48% in 1987.

Breadth measures how many stocks in the S&P 500 are making 52-week highs. A strong market is driven by many areas. For the different dates studied here, there are mixed messages as the 1987 high was across the board, while the 2007 high was only driven by a small number of areas. It seems to us that the overriding factor/indicator is either low breadth or narrowing breadth.

The Relative Strength Index (RSI) in Figure 4 measures the consistency of buying and a figure over “70” is largely seen as overbought or overvalued. All market highs involved the monthly RSI being around or above the widely sighted 70 figures, signaling consistent strong buying over an extended period.


Source: Bloomberg, Team Analysis


Lastly, I thought it would be instructive to look at how other asset classes were performing into the equity market top. If something is going wrong with liquidity or the economy, these assets should be reacting as well (Figure 5).

The bond market is generally seen as a better identifier of recession risks than stock markets and as such, it typically starts to price the central bank cutting rates in advance forcing the yield curve to flatten. The yield spread between the two-year and ten-year yields in a healthy market is typically around 100bps but going into the last two corrections was significantly lower.
Credit markets are also worth watching as again there is a view that credit “fails” before equities. My examination shows this is indeed the case: in the last few cases, spreads have been widening while the market went into a top because of the credit market prices increasing default risks.


Source: Bloomberg, Team Analysis


So back to the original question. What does underestimating risk look like?
The highest risk points for investors, with the benefit of hindsight, was when there appeared little left to worry about. Unemployment was low; consumers were confident; and investors were willing buyers of equities month after month, driving big market moves upwards into the end. I would speculate that during these periods, the “fear” became more about “fear of missing the rally” rather than avoiding a crash.

On the flip side, when everyone is talking about risks such as Europe imploding or North Korea firing missiles, this may just be the time to buy.

One last thing to bring to the reader’s attention is the risk of “false positives”. We only know in hindsight what the tops were. The data can also be consistent with outcomes where a market top doesn’t take place. The most recent example of this was just last year: credit spreads widened, driven by falling oil prices; PMI surveys fell below 50 (indicating a contraction); and the market dropped more than 15% at one point. Yet the data reversed and the market rebounded to new highs. The market is not designed to be easy…

Taken all together, the analysis supports what we have written before: this bull market is moving to the late stages but these indicators I have analysed do not indicate a market top is imminent yet.

As the market continues its grind higher, we will be aiming to stay alert to market complacency and a change in these indicators.


Friday, 01 December 2017 20:51

2018 Investment Opportunities

Clay Smolinski

(Platinum Asset Management)

Monday, 27 November 2017 08:41

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