“As new clients of Jonathan Davis Wealth Mgt we held them in very high regard. This has increased as our relationship has developed. ”

Brian Norman (Mgt Consultant) and Brigit de Wever (Languages) (2012)

2008 and 2009: Years of return OF capital, not necessarily return ON capital

Posted by jdavis on February 2, 2009

We are close to a major turning point in the stock market and during the weekend I considered very carefully what action to take.

Clients may recall that there is a greater than 90% correlation between all major stock markets. So, whether this is the FTSE in London, or the DAX in Frankfurt or the Nikkei in Tokyo, the movement in stock prices has been almost identical. For us, the S&P is the leader of world markets. Hence we focus on it rather than, for example, our own FTSE100. 

The stockmarket plummeted from September 19 to October 10. Then it hung around for over a month and fell – for just 24 hours – on November 20. Since then, it has appeared to ‘want to’ drag itself higher. This is not surprising for the following reasons:

  • The market fell c 45% from October 2007 to October 2008 and a bounce increases its likelihood after such a fall. ( I said in mid-October this could be an 
    interesting place to start going back in on a medium-term view.)
  • Warren Buffet was buying stocks publicly
  • Commodity stocks have risen c 50% since the October lows, giving a help to the wider market
  • Banks have been bailed out globally and are rapidly increasing their margins 
    Central Banks have slashed their rates however the commercial banks have not passed on every cut to borrowers
    Banks have reduced their risks in lending
    Deposit rates have been slashed

From a chart point of view, the market has dallied with the mid-October low many times since then but has not broken the level (except the one apparently false break in November).  Please note, as far as we are concerned, the market does have a collective memory, whether it’s due to average valuations, sentiment or whatever.  Thus, we talk of the market ‘dallying’ and ‘wanting to do something’. It cannot be a coincidence that the market has stopped so often at that one point during each retreat.

I have been short term bullish, as many know. I have, for some while now, thought that the market, in general, could rise 30-50% from the October lows.  That would have taken the FTSE from c 3800 to c 5250 at least.

Indeed, I have reiterated this to clients as recently as the week before last.

There are ominous signs that this last time the market approached the psychological support (last week) it could now break lower.
The economy of the world is in recession. US GDP numbers last week were again truly awful.
The S&P closed on Friday – the last market-open day of the month and of the week – at a value (825) which is lower than the lowest point of Friday 10 October, which was 839.

The psychological line lies at 818.

Also, we have seen some very large US companies’ share prices recently decimated. Examples include Caterpillar, International Paper and Textron. These are huge non-financial companies.

It does appear to me that the stockmarket may go to the November 20 lows, which is c 10% down from where it closed on Friday (The FTSE would probably go to 3500, which is 16% down from the Friday close).  If it does, that may not be the end of the world, as it were.  The world and his dog will be screaming ‘End of the World is Nigh’. It will be all over the papers and the broadcast media.

It could be another frightener like November 20, and it could sharply rise back again as it did then.

If it does go there and break that low, well look out below.

So, that’s the general market.  Within the market there are numerous sectors of the economy, such as financials (banks and insurers, for example), energy (e.g. oil and gas), commodities (e.g. gold miners and agricultural producers).

Let’s look closely at one of those sectors, one very close to our heart as having the potential for significant growth over the next few years.


The index of gold and silver stocks in the US, called the XAU Philadelphia Gold and Silver Index, fell hard in the second half of 2008.  Then it bounced sharply from an index level of c 65 to c 125 at the end of last month – a doubling over around three months – most encouraging.  As I say, back to September / early October levels already.

The price of gold bullion, in US $ has grown manyfold since the ‘absolute’ lows in 2001.  Even though it, like everything else last year, was choppy, in fact gold was higher in $ at the end of 2008 than when it started.  As far as we can tell, this was the only asset class to be up on the year, except cash.  In Sterling, gold was up a simply sterling (sic!) c 45%.

The gold stocks compared to the bullion remained within a band of 0.175 to 0.3 for many years (1997 to H1 2008 barring very minor and temporary movements outside).  As gold has surged during these years, so have the stocks.

Until H2 2008.  The stocks were decimated while gold fell but not hugely.

We believe what this tells us is this: 

  • Gold and silver stocks have been hit much harder than the underlying commodities
  • They are undervalued now
  • They will rise back to the 0.175 to 0.3 ratio band.
    To do so, even if gold stopped rising – and we believe it’s, remember, ‘going to the moon!’ - stocks would need to rise a further 30% just to get back to the lowest point in the 11 year range.

    This appears consistent across the commodities’ space. This is one of the many reasons why we recommend commodities and gold stocks in particular.

Finally, let me remind you how our clients’ portfolios are established.

The bulk of client funds (around 70%, depending on the client) are held with ‘active asset allocating’ fund managers such as Miton Special Situations which is one of our ascribed ‘Moderate Volatility’ funds. In active asset allocating funds, the fund managers move between asset classes, such as stocks, cash, bonds, commercial property, gold etc according to their views of investment and economic conditions.

Every client portfolio is a bespoke portfolio with a mixture of active asset allocating funds (Low Volatility and Moderate Volatility) and strategic asset allocation funds in commodities (commodities in general, gold and agricultural stocks – High Volatility).

In strategic asset allocated funds, the investment is in the stated area(s) eg. gold stocks. Thus, the managers, in this example, move between gold stocks.

Thus, the proportion that clients invest in these areas merely alters according to their moving valuations.

Around 30% of client holdings are in commodity stocks, according to the client’s investment risk profile.  In other words, if clients can accept a higher downside in a calendar year and they seek greater returns in the medium to longer terms, we recommend allocating more to commodity funds.  These were hit hard during the big wider market falls of the 3rd and 4th quarters last year.  After the October lows, they rose sharply and, in general, we’re back to early October levels i.e. before the bulk of falls took place.  They have risen perhaps 50% from the October lows – a much greater rise than the stockmarket in general.

So, our clients’ portfolios are to a greater or lesser degree correlated with the wider stock market.

What to do

Market Movement A:

If the stockmarket tests the November lows then jumps sharply back up this could take the market up some 30% as a starter. This could happen within weeks or a couple of months.

Market Movement B:

If the market tests the November lows and goes straight through then it’s ‘Goodbye Vienna’. The market will likely collapse again and fall a further perhaps 50%!

Our current thinking is that Market Movement A is more likely.  For B to take place there would need to be a number of issues coming together such as President Obama’s stimulus package does not get through the Senate, Oil goes to $20 (taking the oil stocks down with it), the volume number of transactions in the market (sales) would have to double at the November low compared to the volume of transactions that we had last week.

All of these happening together is not likely.

In other words, as investing is about probabilities – there are no certainties nor guarantees – there is a higher probability, in our view, that if the market goes down to the November 20 lows, they will come right back up again.

On that basis, we recommend you sit tight.

If we are wrong and the market goes down to the November lows and blasts right through them then we ask you to be very ready to accept our recommendations to sell much of your funds and hold in cash until it would be safer to go back into the market.

We invite clients to refer friends and family to us so that we may review their arrangements and ensure they are secure.
We invite solicitors and accountants to refer clients to us, similarly.
We invite enquiries directly.

Investors must secure their capital and ensure it retains purchasing power.
At Armstrong Davis we are serious about preserving capital, first and foremost.

We merge our expertise of markets and macroeconomics with financial planning tools to provide excellent financial advice to high net worth families and business people and trustees. 


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