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rick-x200.jpgAugust Market Action, by Rick Eling, Senior Client Fund Manager

“What happened…is that the froth is being blown off the beer. The beer is better without the froth.”

William Miller, Legg Mason, August 28th 2015

China…or not?

Chinese stock markets can confuse western eyes. Trading screens lit full of red- the colour of fortune in Chinese culture- indicate rising prices, not falls. But they were all shining green, for losses, last Monday; even the Chinese government called it ‘Black Monday’. So much colour, so little clarity.  What was really happening?

The tabloid story runs like this: Chinese economic growth falters, so the Yuan is devalued, so an equity bubble bursts, and therefore chaos spreads around world markets. While that analysis makes for punchy headlines (my favorite was “Shanghai Shockwave!” from the Square Mile freesheet City AM), the truth is seldom tied up with such a neat little bow. China got the blame, but the problems that really caused the late August sell-off had been around for some time, saying “just give me a reason!”

“The market had struggled for a year with its inability to move higher. The final catalyst could have been anything.”

James Paulsen, CIO of Wells Capital, 28 August 2015

As an aside, although the Chinese falls have been severe (-46% peak-to-trough so far), this needs to be seen in the context of the massive rises earlier in the year. For 2015 to date, the Shanghai Composite index is down only -2.23%. But the papers only report dramatic losses, never the gains:


Double Dragon

The run-up to last week had seen highly unusual patterns in developed markets. For the first seven months of 2015, the USA’s S&P 500 index hovered in a range no wider than 3.5% either side of its start level for the year. Take a look at this (price only, in USD) chart for 2015:

That ‘flatness’ from January to August is unusual, and it speaks to two factors bubbling away beneath the surface. The first is stalled corporate earnings growth and relatively high share valuations on the popular ‘price-to-earnings’ basis. Last time we had a market wobble (August 2011, the so-called Eurozone Crisis) the trailing P/E ratio on the S&P was about 12; before last week it was nearer to 18. A higher P/E ratio can often (not always) indicate that prices are too high. According to Thomson Reuters, S&P 500 earnings growth was 2.2% in Q1, 1.3% in Q2, and is forecast negative (-3.3%) for Q3. That’s not good for share prices in the short term.

But it’s not earnings alone that are in play. Monetary policy has been at the heart of all market activity since 2008, and it certainly played a part last week. Consensus moved over the summer towards the Fed raising rates this autumn. On its own, that would be enough to give markets pause. Combine it with the earnings issue and you have a better story for what happened last week than “it was China”.

“If you thought there should be a correction, here’s the recipe: the Fed raises rates when earnings growth is negative.”

Richard Bernstein, Investment Adviser, NYC

So How Did We Do?

It’s too early for a full suite of official performance numbers; they’ll be along in due course. I can, however, offer three highlights:

1. Risk-targeted actives outperformed their benchmarks, and few clients took all of the equity pain.

We operate an investment process based on the amount of risk a client needs to take, and can both tolerate and afford to take. This results in few of our investors holding 100% in shares; most are in a controlled blend of shares and bonds.

Risk Benchmark Performance in August 2015

The chart shows how Sanlam’s seven colour-coded risk benchmarks behaved during August. These benchmarks are the starting points of the different portfolios we manage. 

These are only the raw risk category returns, not actual portfolio returns, but they show that, for all the noise of last week, August won’t have bankrupted anybody. The majority of our clients are in Yellow, Green or Blue risk portfolios. Even Violet was only -5.39% down on the month.

This chart, showing the Green Active life/pension fund from the market highs on 13 April to the end of August, shows a small outperformance all the way down:
2. Sanlam FOUR Multi-strategy guarded capital well.  

I’ve lifted the note below directly from the multi-strategy team’s latest monthly report, published on 1 September. The fund protected capital in the month better than many well-known absolute return funds, including Standard Life GARS:


3. Sanlam Smooth (powered by P2) showed encouraging signs and is poised to cushion any further losses.

As you know, the P2 mechanism takes equity risk away as market volatility increases, and adds risk back as things calm down. This takes advantage of a common (but not unbreakable) relationship between direction and risk.

These charts from P2 show how the strategy reacted in August 2015 to the increase in market volatility:


As I write (1 September), the P2 funds that we blend to create Sanlam Smooth are positioned like this:

P2 strategies Funds

Equity Exposure











You can see that all the P2 funds are a long way from full equity exposure, and that one fund (EM) is down below one third exposure. Of the five, it is the emerging market fund which shows P2 at its best. Look at the reduction in losses (chart below) from P2 EM versus the MSCI EM Index since the market hit its last highpoint in April. This is what clients are paying for when they choose P2. And if there is any further downside from EM, the customers will suffer only about a 3% fall (or less) for every additional 10% loss from the index:


P2 Emerging Markets shows the strongest risk reduction because the EM Index has seen the hardest falls. The other P2 funds haven’t (yet) cushioned to the same extent, but that’s only because those markets haven’t fallen to the same extent. The P2 mechanism operates in exactly the same way across all five of these funds; if it works for one, it works for all.

But there is a risk, of course. If the EM index rapidly spikes upwards then most of those recovery gains will be missed. This would be the dreaded ‘V-shaped Market’ pattern that caused Sanlam Smooth to lag behind indices since Q4 2014. If you want dynamic downside risk management then you have to accept the risk of lost upside in some conditions. I don’t know a way around this.  If you do, let me know…

So, where next? The FTSE is having a bad Monday again to begin September, closing down nearly 200 points at 6058. The City remains concerned about earnings, rate rises, Chinese slowdown and many other factors. But there are causes for optimism, too. Barry Cowen, our lead portfolio manager, picks out the fall in oil prices and the high levels of cash in investor portfolios (a cushion against lower prices), to name just two.

As Barry himself puts it: “We watch, and wait…and we certainly don’t panic.”


This note is to be used by Financial Advisers only. It is not intended for onward transmission to a private customer and should not be relied upon by any other person. Sanlam Investments and Pensions accepts no liability for any action taken or not taken by an individual or firm as a result of the contents of this material. Whilst we have made every effort to ensure the accuracy of this material, we cannot accept responsibility for any consequence (financial or otherwise) arising from relying on it.

Sanlam & Sanlam Investments and Pensions are trading names of Sanlam Life & Pensions UK Limited (SLP (Reg.in England 980142)) and Sanlam Financial Services UK Limited (SFS (Reg. in England 2354894)). SLP is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. SFS is authorised and regulated by the Financial Conduct Authority. Registered Office: St. Bartholomew’s House, Lewins Mead, Bristol BS1 2NH.

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.