Over the last few months, I’ve grown increasingly cautious with my own investments – I haven’t committed any new money to the markets since the beginning of last year. But this doesn’t mean that I think sell off is imminent. As I’ve been droning on about for ages, we must be near the late stages of the current stock market cycle, but markets may not correct for at least another 6 to 18 months. Still, I think it’s worth taking note of the constant trickle of ‘warnings’ from seasoned market experts. The latest warning this week comes from London based research firm Cross Border Capital. It’s numbers are widely used by hedge funds, especially those interested in how global financial flows both from central banks and big corporates.
Its latest missive is entitled “What Capital Flows Tell Us About A Coming 2018 Correction?” – and I think most readers can guess the answer. Trouble’s brewing! The punchy short note starts thus:
“We are worried. Bear markets in risk assets are frequently driven by the concurrence of three liquidity-based factors:
- high investor risk appetite readings
- high, but skittish cross-border capital flows, and
- Central Banks determined to keep tightening”
Each one of these signals on their own might amount to nothing, but all three spells trouble.
In particular, Cross Border reckons we should focus on the US credit system which will be at the forefront of the coming storm. On the upside Cross Border believes that Asia “looks the most attractive region the other side of any sell-off. What factors could change our view: a reversal in Central Bank tightening actions, for starters, and signs of a sustained recovery in cross-border flows. On the other hand, our Asian views would be compromised by an unexpected tightening by China’s People’s Bank (PBoC).”
One might reasonably ask whether Cross Border’s financial models have any predictive success ? Apparently yes but with the usual big cavaets. Their model “ currently puts odds of around 80% on a substantial market correction in the next 6-12 months (defined by a 15% fall in the MSCI World Index in US dollar terms). …. The model is not fail-safe. Over a 30-year time span, it correctly predicted 66 bear market months out of 111 in total (or around 60%), and it correctly identified 233 bull market months out of 249 in the sample. In other words, it shows 6.4% false negatives and 40.5% false positives. In aggregate terms, this translates in an overall error count of 16.9% and a net gain in predictability over simple ‘coin-flipping’ of 45%. Not perfect, but not at all bad. Certainly, enough for us to heed its warnings.”
I can’t say I’ll be rushing out to sell all my holdings based on analysis like this although I think Cross Border is probably right to use a 6 to 18 month time window. That seems sensible to me, and implies I might slowly take profits and accumulate cash.
But I’m also aware that we may under- estimate the bulls who haven’t gone away. In particular, I think the UK market might be a slightly better place to park your money in this late cycle. US equities have made all the running and UK valuations look slightly more reasonable in value terms. Crucially if you look at the table below you can see that UK equities are still lagging behind US equities on most 1 to 6 year reference points. The UKs focus on resource stocks will help and I think we could see the FTSE 100 breach 8000 at which point I’d be looking to put on a few judicious hedges. UK equities still have some catching up to do when compared with US equities.
UK vs US price returns
|Price change %/ Index||Close||1 month||1 year||5 years||6 years|