Churchouse Letter
September 2015        by Peter Churchouse

Keeping Calm Amidst the Storm

Markets are being rocked, but keeping a cool head will help you make the best out of volatile times...

We are in a correction. The headlines are hysterical, but there's no need to panic.
We turn bullish on a sector that has already given us double digit gains in the past 12 months... but we're not buying just yet.
We give some other simple suggestions for how to ride out the market volatility, strengthen your portfolio, and pick up bargains in the meanwhile.

In the middle of the market chaos last week, I got a text message from a close friend. He is a banker in a very senior position at his company, and worth a fair penny.

The fluctuations of the market had him bothered. Watching Bloomberg that morning before he left for work had worried him even more.

China’s economic malaise was clearly going to spread worldwide. We were heading into the Global Financial Crisis Part II. At least that’s what the pundits predicted.

“Should I dump everything?” he asked. And he wasn’t kidding.

My friend and I rarely discuss finances together. But here was a stable, steady banker considering cashing in all his hard-earned gains because of a couple of bad weeks. I had to tell him to sit back, take a break … and change the channel if the Bloomberg voices get too loud.

The media have a problem. Stock markets, finance, economics … these are rather boring topics for the vast majority of people.

You, on the other hand, represent the minority. Not only are you interested in financial matters, but you pledge both your money and your time to process what I write.

Mainstream media are far less fortunate than my little publishing business…

The 24-hour rolling T.V. news cycle needs eyeballs to sell ad spots to.

Financial Web sites need clicks for their banner ads and sponsored content.

Financial journalists have to compete not only against other financial media, but also against war, explosions, disasters and scandals for a spot on the front page.

And what sells better than anything? Disaster. Crisis. Collapse. The end of the world… live on CNBC… just tune in!

The loudest and most-extreme views receive a hugely disproportionate share of the airwaves. Why? Because it’s entertaining! Viewers like their heroes and villains.

Nobody really seems all that interested in a measured and analytical assessment. It’s too boring.

My banker friend is not alone. I’ve been approached by plenty of people, panicked looks on their faces, asking if they should “sell the house.”

The fear has got to them. They need to tune out the day-to-day noise.

Let me give you a better idea of what I’m talking about. Take a look at these sets of headlines over the course of 9 days earlier this month.

Hyperbole… contradictions… emotionally loaded words like “chaos”, “aftershocks”, “carnage”… and my personal favourite “Bearmageddon”.

When confronted with this barrage of schizophrenic headlines, it pays to remember that the market is not a straightforward, rational reflection of the world… it is a reflection of the actions of its participants.

And the participants are essentially a herd that has a tendency to be driven by emotion… fear and greed.

I am constantly amazed how the media tells me exactly why the market did what it did on any given day. How do they know? Nobody asks me why I bought or sold a stock?

In the absence of a highly visible catalyst, the harsh truth is that often we simply do not know why a market rises o falls in the space of 24 hours. It just does.

And trying to explain the market movements caused by millions of participants every single day means we, as investors, are on the receiving end of a huge amount of dubious information.

FIG. 1 Nine Days of Financial Headlines

CNBC
Tuesday 18th August China shares down 6.1%, lead Asia lower on yuan fears
US oil prices near 6-year lows as China weighs
Could the oil slump push this country to default?
Wednesday 19th August Market is at 'historical extremes': Technician
Shanghai market suffers wild swings, more pain to come
Charts show Nymex oil could hit $38 and stick
Thursday 20th August US stock futures tumble as oil teeters above $40
Cramer Remix: Why a drop in oil is a good thing
Oil's slump will end in panic liquidations: Gartman
Friday 21st August Relax, we're about to his bottom in stocks: Analyst
Buckle up! Wall Street set for another wild ride
markets fear global meltdown
Saturday 22nd August Oil recovers to end at $40.45 a barrel
Chaos on Wall Street; Dow in correction
Market 'aftershocks' are coming: Robert Shiller
Sunday 23rd August Chanos on China: 'It's worse than you think'
Cramer: Brutal selloff makes these more attractive
Cramer: Avoid these horrifying stocks in a selloff
Monday 24th August Dow Futures plunge 600 points
Amid carnage, strategists predict bounce, 'go all in'
Markets fear global meltdown
Tuesday 25th August More selling ahead but bull market 'not dead yet'
Traders look to China to stop meltdown
S&P could rally 15 percent this year: Strategist

MarketWatch Logo
Tuesday 18th August This shows stock market bulls are playing with fire
NEED TO KNOW: Why China's market misfires keep rattling markets
China shares tumble 6.2% despite PBOC's big cash injection
Wednesday 19th August August could yet spark a 'classic' lat-year rally
Stock futures slip| Chinese stocks flip to gains after sharp losses
China bear market isn't trouble for U.S. stocks
Thursday 20th August These two indicators are telling you to buy stocks
Why it's great news that investors are dumping U.S. stocks
U.S. stocks slump as oil plunges to new lows
Friday 21st August What's next after market's biggest bloodbath of the year
Ugly stock-market action may result in attractive buy opportunity
Stars have aligned for an extended decline in stocks
Saturday 22nd August Dow 5,000? Yes it could happen, says Brett Arends
Last Great Bubble may be popping: Gayed
Investors haven't been this terrified since 2009
Sunday 23rd August This reveals how you'll react if stocks fall further
Is this the correction that investors have been looking for?
The Last Great Bubble may finally be starting to pop
Monday 24th August There's 'zero' chance that S&P 500's selloff is over, technician says
How market carnage is only going to get worse, in four charts
Why Friday's selloff points to more pain
Tuesday 25th August Wall Street set to come back from 'Black Monday'
Stock futures higher after S&P 500, Nasdaq fall into correction
Mark Hullbert: Top-flight stock-market timers are bullish
Wednesday 26th August Stock futures climb as China tries fresh stimulus
NEED TO KNOW: 'Bearmageddon' is coming | China stocks fall 1.3%
Best indicator 'you've never heard of' is bullish

Crisis? That’s Not a Crisis!

I’ve been through three-and-a-half decades of living in Asia and working in finance.

I’ve lived through the real financial crises – a few times.

I’m talking about the Asian financial crisis, where some Asian stock markets fell by more than 90% in U.S. dollar terms.

I’m talking about Hong Kong’s house prices falling by 70%. Yes, that’s SEVENTY PERCENT!

I’m talking about the crash of ’87, the bubble of 2000… and of course the recent GFC.

Having been around the block a few times, I understand just how easy and tempting it is to panic.

For U.S.-based investors in particular, you could have well over a decade of investing experience yet only have faced a single downturn, the GFC.

But you have to differentiate between a correction and a crisis.

A crisis is when asset values don’t just fall, they collapse.

When interest rates skyrocket overnight. When governments default on their debt. When companies are going bankrupt on a daily basis. When the core plumbing of the financial system fails to operate. When your job, your livelihood rapidly becomes at risk.

And that is not the situation we find ourselves in today, either in the United States or in Asia.

Don’t get me wrong, there are some significant concerns building in the global economy. And we need to address them rationally and understand what the implications might be for us as investors.

But let’s not panic, because nobody ever made a sensible investment decision blinded by panic!

Get Ready to Go Back Into China

We need to start with China. The mainland A-share market has dominated the headlines over the past few months. The bubble, and its subsequent bursting.

We’ve written about this market a lot. And I’ve had no problem calling it like I see it…

“This market can whipsaw very quickly. We’ve seen it before and I guarantee we’ll see it again.

Bear in mind you are TRADING the Mainland China market… you’re not investing in any traditional sense. Welcome to the biggest casino in town!”

~ Peter’s Perspective, “We Need to Talk About China”, 16th April 2015

Right now, the day-to-day behaviour of the Chinese stock markets is simply affecting broader global markets far too much.

It goes back to the media again. Big daily drops in Chinese markets make for great copy. But let’s not kid ourselves. This was always a speculative bubble, from a retail-driven market.

And it in no way reflects anything about the health of the broader Chinese economy!

This quote from Fraser Howie, the co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, sums it up perfectly:

“You can’t ignore the Chinese economy, but the [Chinese] stock market should be for entertainment value, not a daily signal for people to make investment decisions.”

What I do believe has happened is that this extreme bull-and-bear market in Chinese equities has coincided with a shift in perception of the health of China’s economy as a whole.

Let’s be clear: Chinese growth is slowing. And we don’t know the actual rate of growth … it’s probably closer to 5.5% rather than 7%.

Strangely enough, this is no secret. It’s been clear to anyone paying attention for some time now that China is facing growth challenges. What’s different is that now global markets have started paying attention.

I’ve said consistently that we will see more easing measures in the short term.

So far, that has played out as expected. Let’s take a look at three key metrics: the benchmark lending rate, the benchmark savings rate, and the reserve ratio (i.e. the percentage of deposits that major banks must keep as reserves).

The three metrics shown below portray a clear easing trend. The reserve requirement ratio will be down another 0.50% by the end of the week.

But there is still room to go.

Main China Benchmark Rates over the last 15 years: 1Y Lending Rate, 1Y Deposit Rate and Reserve Ratio Requirement

Much has been written about China attempting to transition from an investment-led economy to a consumption-driven one, while at the same time sustaining demand.

It’s not an easy process. And, just like the opening up of its capital markets, it will be fraught with periods of instability.

This is a US$10 trillion economy we’re talking about.

But there are positive signs. Retail sales were up 10.5% year-on-year in July. And household consumption is back to where it was pre-GFC, at around 38% of GDP.

I see opportunity yet again in one particular China segment…


The world is in a correction.

But it's not the apocalypse... It's not the end of the world, and it certainly doesn't have to be the end of your portfolio.

In this issue of The Churchouse Letter we cover:

  • How to stay calm and trust your investing discipline
  • Best practices in a world of falling share prices
  • A sector set to rebound in the near future
  • A defensive move that's been outperforming even during the downturn

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