Ardevora Quarterly Review - Third quarter 2018

It's the End of The World as We Know It (And I Feel Fine)

This is supposed to be a review of the third quarter of 2018, but October has rather overtaken us. Global stock markets are in a panic and October falls have erased the ephemeral gains for the year. From our perspective the behaviour of only one of the three blocks of people we try to track has changed: investors.

When you have lived through a lot of ups and downs of stock markets like me, you tend to trawl your memory banks for reference points when something out of the ordinary happens. It is called the Representative Heuristic, and is one of the ways we try to cope with fuzzy, complex problems. The Representative Heuristic is a good way of dealing with complexity if you have a big bank of relevant experience, but it can also be a profound source of bias if your experience is shallow, or you rely on a memory which isn’t relevant at all. Whether the Representative Heuristic is a source of bias or help is essentially a debate about the usefulness of history: does history repeat itself or do we just try to make sense of inherently unpredictable current events by over-fitting them to the past, regardless of logic?

We believe in the usefulness of history as long as one approaches it carefully, logically and you don’t get dazzled by the Affect Heuristic. The Affect Heuristic is the tendency to focus on similarity of outcome rather than similarity of causes, as a reference. With all of this in mind, what is going on now feels a lot like 1987 to me, so let’s explore this Representative Heuristic a little and see if it is or isn’t just a bad case of Affect Bias.

What happened in 1987? I remember belting out the REM song, “It’s the End of The World as We Know It (And I Feel Fine)” whenever it came on the car radio. The first episode of the Simpsons was aired; it’s still going, so no change there. They started building the Channel Tunnel; it doesn’t look like we’ll be needing that now. There was the great southern British storm and I woke up to find my car under a tree, which was traumatic for me, but otherwise completely irrelevant. The first criminal was convicted on DNA evidence and the first drug for AIDS was discovered; now DNA research is spawning an explosion of R&D in the drug industry. A US frigate was attacked by Iraqi missiles; reminding us how long the Middle East has been a source of angst. And stock markets crashed around the world.

My memory of the violent stock market crash was it seemed to come out of nowhere. Afterwards, metaphorical fingers were pointed at a small rise in German interest rates and the role of automated trading programs called portfolio insurance. There wasn’t any obvious economic trauma building, just an overheating housing market, a bit of a pick-up in inflation and some gentle monetary tightening in a few places. This is why my Representative Heuristic draws me to 1987.

Back then I didn’t think in terms of investor, analyst and management behaviour. I was still young and naïve and believed in dividend discount models, accurate forecasts, macroeconomics and rational man. Now I know better. Most problems in stock markets, in my experience, stem from the herding of management behaviour. Company managers get over-confident and reckless and over-invest in the pursuit of growth, while assuming recessions have been banished. They overpromise, under-deliver and so mislead analysts (who generally trust them) and investors (who forget they are generally not to be trusted). But sometimes investors operate in their own bubble. In 1987 they drove the stock market up on the same “news” they then drove it down on. It was blamed on a belief stock markets could be turned into riskless investing by portfolio insurance. The result was a strangely strong stock market in the first three quarters of the year and then a violent “correction” in the fourth quarter. As stock markets fell, a feedback loop of anxiety kicked in: investors worried whether the falling stock market was either signalling an oncoming recession, which no-one had seen coming, or would actually trigger a recession through negative wealth effects. Such is the circularity of ad hoc causation. A year later stock markets had crawled back to their highs, before climbing for another three years. On a long-term chart of stock markets, 1987 looks like a blip. But it didn’t feel like it at the time.

There is a lot of the 1987 background which seems to feel familiar now. No-one is really worrying about an imminent recession. In fact most worries focus on the potential for inflation to accelerate, hence some tentative interest rate rises; just like 1987. Company managers don’t seem to be over-exuberant, or overconfident. Most companies are not delivering surprisingly awful results triggering large forecast misses from analysts. Investment robots also seem to lurk. Portfolio insurance trading has been replaced by a market dominated by “smart” passive investing in thematically driven ETFs, Smart-Beta and Risk-Parity. Pockets of stocks burst into accelerating momentum and then out-of-nowhere short sharp selloffs. It’s not quite the same as 1987, but the mechanisms feel familiar: automatic buying/selling based on nothing but a stock price and a description; investor behaviour with an unusually elastic tether to the underlying success or failure of companies and their management.

We don’t subscribe to the view that history endlessly repeats itself. We do believe it can repeat, but in different clothes. Our instincts tell us we are in a rough, violent period for stock markets. It seems likely we will have some more terrible feeling days/weeks but we would expect to feel a lot better in six months’ time. Investors will have been scared, scarred and we can get back to a healthy environment of scepticism for everyone.


Important Information

This material is for distribution to Professional Clients only, as defined under the Financial Conduct Authority’s (“FCA”) conduct of business rules, and should not be relied upon by any other persons. Issued by Ardevora Asset Management LLP (authorised and regulated by the FCA). Registered office: 6 New Bridge Street, London EC4V 6AB. Registered in England No. OC351772. Tel: 020 7842 0630. Past performance is not a guide to future performance. Care has been taken to ensure the accuracy of this document’s content, but no responsibility is accepted for any errors or omissions herein. The views expressed do not constitute investment or any other advice and are subject to change. In particular, we are not recommending or expressing an opinion on the merits of buying or selling any securities mentioned herein.

Previous Commentaries

Quarterly Commentary Period ending June 2018
Quarterly Commentary Period ending March 2018
Annual Commentary Period ending December 2017
Quarterly Commentary Period ending September 2017
Quarterly Commentary Period ending June 2017

You are now leaving the Ardevora website and entering a website not operated by us. Ardevora provides links to external websites that you may find helpful, however the provision of this link does not constitute a recommendation or advice.

Ardevora accepts no responsibility for the accuracy or content of the website that you are about to access, or for any action that you take as a result of accessing this website.

Please ensure that you have read and understand the Terms and Conditions of such third party website and contact the operator of the site should you have any queries.

 

IMPORTANT INFORMATION
Regulatory Information

Ardevora Asset Management LLP, a limited liability partnership, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority (“FCA”). This site is directed solely at investors who meet the FCA definitions of Eligible Counterparty or Professional Client, and should not be relied upon by other persons. Specifically, this site is not intended for, and is not suitable for, those investors who would be categorised as Retail Clients as defined under the United Kingdom Financial Conduct Authority’s Conduct of Business rules.

Non Solicitation

The contents of this site have been prepared solely for information purposes. The distribution of the information contained on this website in certain countries may be restricted by law and, accordingly, persons who access it are required to inform themselves of and to comply with any such restrictions. The information on this website does not constitute an offer or solicitation in any jurisdiction in which such an offer or solicitation is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. Any opinions expressed on this site do not constitute investment advice and independent advice should be sought where appropriate. You acknowledge that your use of this website and requests for information are unsolicited.

Risk Warning

The value of investments, and the income from them, can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future performance. This website is subject to express terms and conditions of use. If you are unsure about the meaning of any information in this website you should consult your financial or other professional adviser. By clicking “Agree” below, you confirm that you have read this Important Information section as well as the Website Terms and Conditions of Use which are available on this Website and agree to be bound by them.

The Funds

The Ardevora funds are open-ended investment companies based in Ireland and the UK. Treligga plc, which has six sub-funds, is an open-ended investment company with variable capital organised under the laws of Ireland and structured as an umbrella fund with segregated liability between sub-funds. Treligga plc is authorised and regulated by the Central Bank of Ireland as a UCITS under the European Communities (Undertaking for Collective Investment in Transferable Securities) Regulations 2011, as amended. The ES Ardevora UK Income Fund is a UK based open-ended investment company with variable capital organised under the laws of England and Wales, authorised and regulated by the FCA. The Authorised Corporate Director is EQT Fund Solutions.

Jurisdiction

The information contained in this website is directed only at persons who are resident in the United Kingdom. The information contained in this website is not directed at you if Ardevora is prohibited by any law of any jurisdiction from making the information on this site available to you and is not intended for any use that would be contrary to local law or regulation. None of the services, investments or funds referred to in this site are available for sale or use in any jurisdiction where such activity is prohibited. This website should not be accessed by any person in the United States. Persons who are resident outside the United Kingdom should consult their professional advisers or local regulator to satisfy themselves of local regulatory requirements.

Accuracy of Information

The content of this site is based upon sources of information believed to be reliable, however, save to the extent required by applicable law or regulations, no guarantee, warranty or representation (express or implied) is given to its accuracy or completeness. No responsibility or liability can be accepted for any errors or omissions or for any loss resulting from the use of any materials contained in this site. Ardevora reserves the right to amend, alter or withdraw any of the information in the site at any time without notice. No liability is accepted for such changes or for pages not being available at all times.

Linked/External Websites

This website may contain links to other websites maintained by third parties over whom Ardevora has no control. Ardevora and its employees take no responsibility for approving, screening or reviewing the contents of the linked websites and should not be regarded as an endorsement of the service or the site. Ardevora makes no representations as to the accuracy, legality or any other aspect of information contained in the linked or other websites. You use such links at your own risk.

Copyright

The information contained on this site is subject to copyright with all rights reserved. Under no circumstances should any information be copied, reproduced or redistributed without express prior written consent from Ardevora.

Law

This website is governed by the laws of England and Wales.

I HAVE READ, UNDERSTOOD AND AGREE TO THE IMPORTANT LEGAL NOTICE ABOVE