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ATTRITIONAL BEAR MARKETS

Are we in a bear market and do we expect a V-shaped or U-shaped recovery? How long will it persist? PAUL CLUER takes a closer look at the current landscape and explains the shape of what’s to come.

We’ve written in these pages about the extra-long duration of the current global expansion, which is now undoubtedly in its late stages. Share markets rolled over in 2018 in anticipation of recession as US interest rates looked set to rise further, albeit at a slower pace. The bulls were in retreat.

Yet US Federal Reserve Chair Jerome Powell stood firm on rising rates and quantitative tightening, withstanding an angry Twitter onslaught from President Trump. But in a surprising January policy U-turn after a brief brush with systemic risk, Powell turned dovish on both aspects of monetary policy after markets had fallen 20%. 

The Powell Put was at last in play (see Foreword Issue 45, 1st Quarter 2018, for an explanation of the Bernanke Put). Markets consequently rallied, recouping all of 2018’s losses. It appears that the bears are now at bay.

But are they? The accepted definition of a bear market is a 20% decline from peak to trough. Bear markets can be V-shaped (quick recovery) or U-shaped (more sluggish recovery). But recover they do.

While the Powell Put stemmed further market losses, it simply deferred the inevitable. A global economic recession this year will confirm the bear market. But absent a global recession, stock markets still face headwinds of slowing growth and more distant interest rate increases. We believe we’re into the realms of a slow-burning, attritional bear market.

Because developed market interest rates will now take longer to normalise, market valuations will have better support. The result is that quality companies are fully priced. But any adverse, stock-specific news results in panicked selling so typical of bear markets. 

Attritional bear markets therefore act at stock level. The V-shapes and U-shapes will be evident in price graphs of individual companies rather than the broader index of stocks.

South Africa has its own economic challenges but is still much more open to the world than it used to be. Commodities are no longer the main economic driver. The country will therefore not experience the types of commodity-shock bear markets of its past. But it is in an attritional bear phase.

Last year, several quality JSE-listed businesses were heavily punished for not unusual operating or financial headwinds. The market’s reaction was brutal and likely overdone with no discrimination between instances of permanent capital destruction and those where the headwinds are temporary. Leveraged (see Did You Know?) companies that are still benefiting from low interest rates weren’t spared.

Recent examples are Richemont, British American Tobacco and Anheuser-Busch Inbev, which all de-rated in 2018. These stocks are amongst the best performers in 2019 as the market reassesses leveraged companies more favourably, given the Fed’s policy U-turn. 

This is a tailwind to Foord’s portfolios where quality companies capitalising on cheap leverage was a specific theme. We believe that Aspen falls into the same category.

Attritional bear markets provide similar opportunities to long-term investors to market-wide bear markets. Patience, diversification and generous liquidity must be the order of the day. In this environment, investment returns will come from earnings and stock-picking, not from rising markets.

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