Are the Bears Growling?

The outstanding investment returns produced by world stockmarkets over the past few years have been described by many commentators (and I include myself in this group) as ‘the most hated bull market of all time’.  This group of commentators 
1) understood why there was a bull market, and
2) were confident in its progression.  

However, as you are bound to realise from the inevitable sensationalist news reporting, it came to an abrupt halt yesterday.  If this group’s confidence is founded on sound thinking then the past few days of sharp declines in valuations are a short-term phenomenon and not the precursor of a protracted bear market.

 

Why do I think this way?  Allow me to step back.  Post credit-crunch, central banks took on a much more influential role in the fortunes of investors.  Indeed, the US stockmarket has performed at its best around the time of Federal Reserve (FOMC) meetings – Mrs Yellen merely had to turn up to a meeting for the market to advance.  Indeed, until last Friday, it seemed to matter not what was said. Unfortunately for Mr Jerome Powell (Mrs Y’s successor at the Federal Reserve) the markets decided they did not like the comments regarding higher than expected wage growth leading to  the higher inflation and, thus, higher interest rates.  

 

It is the last of these which seems to have spooked markets – despite three rates rises by the Fed last year, and a signal given before Christmas of three further rate rises this year, investors seemed to have suddenly realised that much higher interest rates matter.  They are quite correct.  Interest rates have been kept artificially low by QE; as this is wound down rates should rise and, indeed, the Fed has followed the course predicted.  Thus, the question is how shall markets react?  Goldilocks holds the key.  As long as rates are neither too low nor too high the perfect environment exists for further equity growth – the assumption being that the ideal macro environment created by central banks provides benign conditions for corporate profitability.

 

It has been the position of this firm over several years that interest rates shall remain lower for longer than many expect.  Even after the recent rises, rates are still very low.  I do not foresee a return to the high interest rates of the recent past.  Indeed, should inflation grow faster than anticipated (which, in the past, compelled central banks to increase rates) I do doubt that central banks shall be so trigger happy.  This leads me to (one of the) over-riding long-term macro issues – the level of debt – both governmental and personal.  Debt is reduced by inflation – and I expect central banks and governments to allow inflation at higher levels to erode their debt.  The alternative is debt destruction: a repeat of the Credit Crunch or 1930’s.  Governments will not allow a repeat of history.

 

Back to Goldilocks.  As she enjoys her porridge at the ideal temperature the bears are not growling at her.  At this point in the economic cycle marginally higher interest rates can be absorbed by the economy and corporate profitability has been supporting higher equity valuations.  That said, some valuations in certain sectors look stretched and I do expect to see volatility, the like of which is happening at the moment, being more common throughout 2018.  However, it is not, in my opinion, signalling a structural change into a prolonged and pernicious bear market.  

 

Volatility is unsettling.  I do not like to see my clients’ valuations move lower by a few percentage points.  However, we have to remember that the price to pay for participating in equity growth is volatility – prices can fall as well as rise.  If I have done my job properly investors are focusing on the long term objectives and can absorb, within their circumstances, period of falling asset values.  Indeed, the preceding paragraphs discuss equity valuations – the majority of portfolios are spread amongst different asset classes and geographies so as to reduce equity risk by diversification.

 

Last month this firm won its fourth investment award in three successive years. Sponsored by Schroders the Portfolio Adviser Wealth Manager awards are chosen by an independent judging panel, representing the best of financial planning, law, accountancy, consultancy and trust businesses. The judging panel make their decisions on two criteria: scenarios based on client needs and from portfolio data provided from each entrant. A quantitatively driven research report on each portfolio was given by Enhance Group who worked closely with Portfolio Adviser to provide the due diligence on each of the entries. We were awarded Gold in the Aggressive category, giving us the full set of gold awards for Cautious, Balanced (both Gold and Platinum) and Aggressive.  Without your support this would not have been possible.  I am grateful for the support and trust shown by all of our clients.

Andrew Longbon

For, and on behalf of, Longbon & Company