Our view on the recent market madness and how it affects AIM

With global stock markets experiencing a volatile summer, and this week in particular witnessing some bizarre movements from leading indices, we thought it an appropriate time to offer our thoughts.

The start of the week saw the largest ever intra-day points move from the Dow Jones Industrial average. This bizarre short term move saw shares in solid blue chip companies such as Apple, General Electric and Microsoft down more than 10% in the space of a few minutes. Contagion spread to other stock markets all of which followed the US lead and tumbled.

At times like these, when trading frenzy takes hold, our usual course of action, which has served us in good stead over the past decade, is….to do nothing!

While the sell-off was initiated by the stock market rout in China and mounting concern over the state of the Chinese economy, a short term move of this magnitude has little to do with worries over economies or company fundamentals. Rather, it has more had more to do with computer trading programmes triggering vast sell orders as so called index ‘support levels’ were breached and the share prices of the 3 US giants above swiftly bounced.

Addressing the China issue first, it is evident there are concerns over slowing Chinese growth and the seeming inability of the authorities over there to control their tumbling stock market. While the Shanghai Composite index has tumbled a whopping 45% since hitting its high on 12 June 2015, it still remains up over the 12 month period and only 10% below the level at the start of 2015.

To put things into perspective, a stock market that rises well over 100% in the space of 12 months and sees many of its constituent companies trade at ridiculously high valuations is bound to experience a reality check at some time. In response, Chinese authorities have already devalued the Yuan, cut interest rates by 0.25 percentage points and also announced plans for its main state pension fund to be able invest in the stock market for the first time. They will clearly be prepared to do more to stabilise matters and support the hopes of their vast population.

There are indeed mounting concerns surrounding global growth prospects, reflected in the decline in commodity prices, and the era of low interest rates has boosted the share prices of many companies, sometimes to unsustainable levels.

However it’s not all gloom with plenty of excellent businesses with good growth prospects (notwithstanding China and global growth concerns) trading at fairer valuations. The UK market recovered strongly following the financial crisis.

The current stock market correction that we are now experiencing should therefore be viewed as a healthy development in the normal cycle of things offering, if anything, opportunities for the patient long term investor.

During such volatile times the share prices of smaller quoted companies on AIM often tumble more precipitously than their larger brethren, simply due to reasons of illiquidity, notwithstanding the merits of the business, their financial strength or prospects. With many AIM stocks having experienced a good run over the past few months it shouldn’t come as surprise that many investors decided to take their profit at the first sign of trouble.

The result of this is that several of our portfolio companies have seen their share prices fall from recent highs. We have seen this sort of irrational behaviour on several occasions over the past decade or so, following which our client portfolios have thankfully benefited handsomely. Our diversified approach to investing in smaller quoted companies also serves us well during such times and, with no single stock having a material influence on individual portfolios, overall returns on portfolios remains strong.

Sharp corrections in the AIM arena for no fundamental stock specific reason often present excellent buying opportunities for the patient long term investor that is willing to ignore the short term noise. AIM stocks (even the lower growth variety) are generally much higher growth propositions than their main market counterparts, accordingly the global growth concerns prevalent in main market stocks with their big international exposure are of less relevance to the lower end of the market.

We look forward to the irrational behaviour continuing this week and we sense that the beginning of September could offer an excellent buying opportunity.