INVESTOR WORRIES DRIVING MARKET VOLATILITY
- Fed concerns
- Trade wars
- Decelerating global growth
- China’s economic deceleration
- Falling oil prices
- Geopolitical instability
- Simmering debt bubbles
OUR APPROACH: STAYING FOCUSED ON THE LONG TERM
What’s driving the current volatility? Rather than one or two factors like economic health or the direction of interest rates, investors are feeling uncertain about a number of things whose aggregate potential impact on stocks could be highly unfavorable.
A powerful combination of market drivers
These are the factors that we believe are collectively driving market volatility:
Fed concerns. The Fed has tightened monetary policy in the past few years to reduce the odds that economic growth will overheat and lead to rising inflation. Investors naturally worry that too much tightening will push the economy into recession.
Trade wars. Investors are concerned about the effect that President Trump’s stance on trade might have on global economic growth. Supply chains—many of which include companies in our smaller cap investment universe—are feeling pain as tariffs make their way through the system. Anecdotal evidence, furthermore, suggests that even the most financially sophisticated companies are unable to model how the trade wars will play out, which is a challenge for stocks.
Decelerating global growth. The synchronized global economic growth that spurred investor confidence just 18 months ago has transitioned to a greater dispersion among nations. 2019 US GDP forecasts, for example, are dropping from the 3-4% range to 2-3%. Germany, long the economic anchor of Europe, just experienced its first quarterly economic contraction in three years. Japan also reported a third-quarter contraction (-1.2% annualized), its second quarterly loss of the year. Growth in China also continues to slow, impacting emerging markets.
China’s economic deceleration. The Chinese economy, a source of outsize demand for products and materials produced elsewhere in the world, is slowing down, with domestic factors and US tariffs largely responsible. Third-quarter YoY Chinese GDP growth was 6.5%, the weakest such pace since the first quarter of 2009. Corporate CFOs are saying that they’ll make decisions more conservatively if the tariffs persist and China’s growth continues to fall.
Falling oil prices. The price of oil is plummeting, primarily based on the build-up of global supplies and uncertainty about whether Saudi Arabia will cut its production to cushion the fall. Energy stocks have been hit hard. While cheaper oil usually is considered a type of tax cut for non-energy companies, this time it seems to reflect concern that global economic growth is softening.
Geopolitical instability. US investors are paying attention to developments overseas, especially in the Middle East and Europe. The Middle East is rife with political and/or military tensions, while in Europe, the economic fallout both from Brexit and Italy’s unchecked spending could possibly affect other regions as well.
Simmering debt bubbles. With so many other sources of volatility to think about, there are potential debt bubbles—historically a harbinger of financial and economic upheaval—that are flying under the radar. While these are perhaps most glaring in China and Italy, where sovereign obligations are massive and credit quality is weakening, the US has its own mountain of public and corporate debt that could become an economic albatross if rates continue to rise.
Our approach: Staying focused on the long term
The market’s current volatility, while understandably worrisome, is neither new nor extreme. We’ve seen it over the years. If anything, it reinforces our conviction in the essential nature of what we do: We buy innovative companies whose success—as measured by future revenues, earnings and/or price appreciation—we expect to materialize over a period of one-to-two years, not months.
That said, we recognize that revenue and earnings visibility for stocks could be low in the near term and, as part of our normal investment process, we have made some adjustments to reduce risk across our portfolios.
A benefit of the market downturn is that we’re finding more of the type of companies we favor available at attractive valuations. These are companies whose competitive catalysts—notably innovation, disruption and rapid change—should fuel earnings growth that not only outpaces most other companies, but also accelerates while doing so.
The bottom line: We remain confident in the stocks we own and seek to take advantage of more attractive valuations to position the portfolio for future gains.
Nicholas Investment Partners, L.P. (“Nicholas”) is an independent investment adviser registered with the SEC. Registration with the SEC does not imply a certain level of skill or training. The firm maintains a complete list and description of performance composites, which is available upon request. Policies for valuing portfolios, calculating performance, and preparing presentations are available upon request. Past performance is no guarantee of future results. This information is intended for institutions, consultants and qualified investors only. No part of this material may be copied or duplicated, or distributed to any third party without written consent.
Nicholas does not guarantee the success of any investment product. There are risks associated with all investments and returns will vary over time due to many factors such as changing market conditions, liquidity, economic and other factors. The value of investments can go down as well as up, and a loss of principal may occur. Although Nicholas attempts to limit various risks, risk management does not imply low risk. All risk models are inherently limited and subject to changes in economic, political and market conditions, as well as changes in the strategies’ holdings, among other things, which could affect the risk profile of any portfolio managed by Nicholas. Small- and mid-cap companies may be subject to a higher-degree of risk than larger more established companies’ securities. The liquidity of the markets for these small and mid-cap companies may adversely affect the value of these investments. Concentrated or sector strategies are expected to maintain higher exposures to a limited number of securities or sectors which could increase the volatility, market, liquidity and other risks of the strategy.
Some information herein reflects general market commentary and the current opinions of the author which are subject to change without notice. It is provided for general informational purposes only and does not represent investment, legal, regulatory or tax advice and should not be construed as a recommendation of any security, strategy or investment product. There is no guarantee any opinion, forecast, or objective will be achieved in the future. The information, charts and reports contained herein are unaudited. Although some information contained herein was obtained from recognized and trusted sources believed to be reliable, its accuracy and completeness cannot be guaranteed. Unless otherwise noted, Nicholas is the source of illustrations. References to specific securities, issuers and market sectors are for illustrative purposes only. Nicholas does not undertake to keep the recipients of this report advised of future developments or of changes in any of the matters discussed in this report.
Nicholas used third-party information in the preparation of the characteristics and market environment charts. While Nicholas believes the third-party information was obtained from reliable sources, we cannot guarantee the accuracy, adequacy or completeness of the information obtained from these sources.