This month, we received several questions from our investors about how the Hamas-Israel war would impact the performance of our Fund. And, as a bonus, where the stock market will be six months from now?
Let’s start with the second one. We have no idea. We watch the markets closely, but we have no crystal ball (or a DeLorean time machine). There are quite a few ‘experts’ out there who earn a living, or status, predicting the stock markets based on current trends, developments, and other information.
Apple Tree is not in that business.
Our expertise is managing tail-end risks and making a return for our investors based on that. Tail-end risks are risks that occur not that often, but when they do, have the potential of creating a huge (negative) impact. In the financial markets, examples are Black Monday 1989, the 2008 financial crisis, or more recently COVID-19.
Coming back to the first question then, “How does this war impact the Fund performance?”.
The war has the potential of disrupting the markets in the short term. To what extent is not clear, but that is why our risk framework, that we have built over the past 25 years, consists of many early warning indicators. If the risk gets too high, following our fixed set of rules, then we will take a (small) loss, which we will most likely be able to undo in the next 2-3 months because of higher volatility in the market. But historically, wars have less impact on the markets than people may think. A few examples from different analysts and experts.
According to Jeroen Blokland: “Historically, #geopolitics, including short-term 'shock events,' had a limited (immediate) impact on #equitymarkets. To have a more profound impact, you will have to make the case that current events hamper the cash flow and # earnings-generating capability of (major) listed companies, which would result in a structurally higher required risk premium.”
Jan-Willem Nijkamp of Fintessa shares something similar (Dutch only): https://nl.investing.com/analysis/beursen-in-oorlogstijd-200212901.
Michel Arouet states: “Nobody can predict at the moment how the Middle East situation will unfold, but if history is a guide market impacts of geopolitical scares are usually short lived. Will it be different this time?” Or put differently: we know that history repeats itself, but also that it is no guarantee for the future.
Our conclusion: the war is one of the developments / risks we keep a close eye on. But it is not the only one, or even the main one.
To showcase this, we use a graph from Goldman Sachs. It plots the VIX to the news-based Geopolitical Risk Index since 1980. The VIX is the Volatility Index, and it is a measure of panic; the higher the VIX is, the more panic there is in the financial markets, which usually comes with lower stock markets.
Following the GS analysts: the graph shows a mixed relationship, in part because macro conditions at the time matter. Geopolitical events’ impact and timing are hard to predict, and history suggests such occurrences don’t exhibit any consistent pattern across assets. In other words, there is a lot more than geopolitical unrest that can create panic in the market.
Are you curious what some of those risks might be? A small sneak peek into the minds of Apple Tree: two examples of such risks (we cannot give away every secret).
Something we have been following since 2022 already, after our first shock of the Russian invasion had ebbed away, is the continued and rapid decline of the growth of bank debt to companies. Bank credit has now entered contraction territory (meaning that companies can get less or no credit, are unable to grow or roll over their current debts and potentially file for bankruptcy). Since 1974, this has only happened once. You guessed (or saw) it, the Global Financial Crisis. At the current rate, the risk of a credit event is on the rise. We’re not saying that this will happen again, but it is something that is not in the news, but a real (tail-end) risk with a potentially big impact.
Example 2 is even less visible: U.S. Treasuries are now at some of the most oversold levels seen in the past 36 years, levels which have historically preceded events like the October 1987 crash, the Dotcom Bubble, and the Nasdaq spike in October 2022. Again, this is not a predictor of the future, it is a risk (or an indicator), and a reason for us to be a bit more extra vigilant.
But we only invest in European indices. So why these two examples from the US?
Have you ever heard of the saying,” When the US sneezes, the rest of the world gets a cold”? That is why. Even today, that still holds true, as the $109T Global Stock Market picture shows.
The global stock market market cap is $109T
The US makes up 42% of that; the EU (only) 11%
The US’ share is forecasted to decrease to 35% by 2030 (fortunately?)
That we keep an eye on the US, amongst other markets, does not mean that a bad market week like 16-20 October gets us unduly worried (the picture shows the weekly losses in the S&P500 of 16-20 October - ouch).
Sources: BofA, Syz Group, Game of Trades, Jeroen Blokland, Fintessa, Michel A. Arouet, Goldman Sachs, Visual Capitalist, Apple Tree Capital Partners