A short though slightly fearful note today.
Like many investors, I’m always on the lookout for signals of impending doom in the stock market. The most obvious clues come from stretched valuations, especially in the US. Yesterday analysts at French bank SG observed that global equity markets rose 2.1% in September, with MSCI World surpassing 2000 for the first time and in turn delivering its eleventh successive month of positive total returns. According to SG “this ranks as the second longest period of consecutive gains for MSCI World since its formation in 1969, with realised volatility collapsing as a consequence. Such a long period of gains, coupled with exceptionally low volatility, inevitably builds up risk in the financial system; low volatility is simply high price confidence and when confidence in asset prices is high, investors do risky things.”
To be fair to the bulls – and I am probably one of them with my portfolio 90% invested at the moment – these surging prices are being sustained by increasing profits (which might also be more likely taxed if President Trump ever gets his way). Again, according to SG, “MSCI reported profits rose by 20% over those 11 months and the actual reported P/E has fallen a shade. However, EPS levels are merely back to where they stood in November 2014, when MSCI was 15% lower, and overall profits have yet to exceed 2008 levels when the index was a third lower. Essentially QE sustained equities levels in anticipation of a profit recovery, but rather than de-rating as those earnings came through, markets are simply being propelled to ever higher levels. The equity valuation problem was created during the 2011-15 era when global profits went nowhere, yet equities rose 30%.”
The surge in equities isn’t exclusively a US thing though. Howard Silverblatt over at S&P Dow Jones indices observes in his end of the month note that “non-U.S. global gains continue to outperform the U.S. gain from the post-election Nov. 8, 2016, period, as non-U.S. markets have gained 19.43% and the U.S. has gained 18.48%. The variance is attributed to the timing of the global recovery, which trailed the U.S. Over the longer term, the U.S. still dominates the gains; the global three-year return is at 18.08%, but absent the U.S.’s 27.84%, the three-year return is 8.83%. “.
Back here in the UK, my own signals tend to be a little more parochial – I look for instance at new or existing funds raising cash or new retail bonds that suggest a worrying trend. On both scores, I’ve seen a couple of small news items that warrant attention.
The first is that a property REIT called Civitas is proposing a new £350m fundraising, on top of its existing initial funding round earlier this year. The manager says it needs the money because it “has access to an investment pipeline in excess of £500 million over the coming 12 months (of which approx. £100 million is expected to be available in the near term), subject to due diligence and binding legal agreements, and therefore requires additional equity to ensure continuity of investment”. But this fundraising comes on top of two very big issues from rival funds which have raised around £500m – all for social housing, mostly on an assisted or supported living basis.
Again, I’m not going to repeat my concerns with this niche segment. My current observation is that an astonishing amount of money has been raised for what is in effect a very narrow, less than liquid niche. I hope all the extra money helps with our slow-burning housing crisis but I have my severe doubts.
The other warning signal came with news that the latest retail bond on the LSE is from Select Property Group which is seeking to raise money on a 6% bond through to 2023. I’m sure that this specialist in student housing and private rented accommodation is a quality outfit but I really can’t get excited about this offer.
Select is a private business that by my estimates should easily be able to raise cheap wholesale or bank funding at rates well below 6%. It looks smart and well run although it doesn’t seem spectacularly profitable. More to the point it’s in sectors that I suspect might be a little ‘toppy’ such as student flats and affordable private rented accommodation (PRS).
I recently noticed a news story which suggested that returns from renting are near all-time highs which surely must be a warning sign if ever there was one! We are collectively increasing the charges to those with the least ability to afford them, pushing renters into high debts just to have a roof over their head. I think that the rent controls suggested by Labour are complete lunacy but I do observe that virtually every expert on this subject thinks that the ONLY long-term solution is to
- Massively increase the supply of cheap affordable housing in order to
- Reduce rents i.e reduce investor yields.
I’m sure that most buy to let landlords have a clever survival strategy and I don’t doubt that Select has a great growth plan, but it all smells to me very ‘late-cycle’. If that is the case a 6% yield for six-year duration risk doesn’t strike me as a suitable reward.