Almost by definition, the narrative is loudest and most plausible just before a turning point as the last person has to be persuaded to buy, which leads to a lot of aggressive mean reversion.
Think back to 2015. Everybody loved China, which roared ahead in the first half before collapsing mid-year. By 2016, everybody hated China, but it started to rally in the fourth quarter and had a spectacular year in 2017, making it a top pick for 2018, whereupon it ended up as one of the worst performers again.
Much of this was driven by a general view on emerging markets (of which greater China is a major index constituent), which in turn reflected a view on the US dollar; a weak US dollar is seen as good for emerging markets and vice versa.
Australia gets caught up in this too. The Aussie dollar has a higher correlation with the Shanghai Composite and a general basket of EM currencies than it does with accepted fundamentals such as copper prices, coal prices or the level of interest rates.
Thus the real reason for last year’s mean reversion on EM was the mean reversion in the dollar rather than the widely held explanation of trade wars.
Certainly they are an important factor to take into account, but the new consensus emerging that China’s economy is somehow collapsing as a result – and thus the whole region should be shunned – is fundamentally misplaced.
Not much is happening to disrupt “how much my companies will earn?”
The bigger challenge for this year is the ongoing de-leverage of the global financial system, partly due to the winding down of QE and partly due to the fact that US dollar cash is now a viable alternative investment and a meaningful challenge to a variety of alternative investment funds.
As such, we have a challenge between how much I might be prepared to pay for earnings and the price being offered by Mr Market.
A fund charging “two and 20” now needs to deliver a return of 5 per cent simply to beat cash so that, rather than seeing a Santa Claus rally in December as markets recovered from oversold conditions, we instead saw widespread redemptions across hedge funds, many of which were leveraged, creating a level of distressed selling that has pushed the price Mr Market is offering even further away from intrinsic value.
The fear driving prices is not about expected earnings, or the correct level that we should pay for them; it is of being forced to liquidate positions. In this we are in a similar position to early 1999, after the collapse of LTCM forced it and many other similar alternative funds to sell into illiquid markets.
Then, as now, we looked for fundamental reasons to explain price weakness and were caught out when markets recovered sharply. That was a good time for fundamental, value-based strategies as indeed was the situation 10 years later in early 2009 when there was similar distressed selling, and I suspect with hindsight we will see that another decade on, early 2019 was more about forced liquidation than changes in fundamentals.
So in my view, those with the luxury of cash to invest and a reasonable time horizon should certainly be getting a little more greedy while the leveraged short-term traders are fearful. Happy hunting!
Mark Tinker is head of Framlington Equities Asia at AXA Investment Managers in Hong Kong.