Is this the really big one? Is the US bull market finally at an end? As I write these words the S&P 500 is now down 3.54% over the last month, at 2785. Crucially, for all you technically minded investors, the US benchmark index is within staggering distance of pushing below both it’s 20 and 200 moving average. Once the index pushes is below 2785 we’ll be in interesting technical terrain.
But I would also suggest some perspective. On a one-year basis, the index is still up 9% and even on a six-month basis its up 5%. In sum, the index has simply paused for breath. We are still a long way from a full-throttle market sell-off. Crucially I’m not entirely what new pieces of information the market is reacting to. Yes, US interest rates are rising and yes the yield on US Treasury 10 year bonds has risen above 3%. Yes, the threat of trade war is growing, and Turkey is a mess. But these are hardly new bits of information. Commentators like me have been worrying about rates tantrums and EM squeezes for ages but the markets have chosen to ignore these concerns, until now. Another argument is that the tech bubble has finally burst. One core story doing the rounds is that as regulatory pressure intensifies, costs are increasing and thus profits falling. Maybe this is true for Facebook but I’m not so sure that this is the case for most of the other FAANGs.
Another argument is that valuations have simply become too rich – and thus we are at almost a gag point where investors think that stocks are just too damned expensive. At which point, of course, the good old long-term cyclically adjusted price to earnings ratio is trotted out, even though it has the predictive accuracy of a bowl of jelly. And if rich valuations really were the driver, why is it that some equity markets such as the FTSE 100 are getting harder hit compared to the S&P 500. As I write the FTSE 100 is down 6.8% over the year and over 7% for the last three months. On my set of measures the UK now looks very cheap especially if our government was able to miraculously produce some Brexit fudge.
So, in sum, I’m not convinced this ‘is it’ – the big sell-off. The market is simply recalibrating likely expected returns, which will be burdened by increased levels of volatility. That said – as I have recently observed in my FT column – I am much more bearish for the medium term and have been taking risk off the table for many weeks now. But I wouldn’t be racing out to suddenly sell everything in anticipation of a proper 10 to 20% blow up. This is now a tactical investors market. You can buy quality on the dips and then sell out before the next volatility squall comes along. But what has vanished is the steady 10% per annum expectation of gains – the brave new world is all about scratching around for a few per cent a year of gains. Every year for the last ten years we’ve been told that ‘this market is finally going to be an active stockpickers market’ and the sages were wrong. Passive funds have destroyed everything in their wake. Now, I think, the tide really is turning. This will be a market for stock pickers – many passive funds might struggle.
Then again, perhaps I am far too cynical. Quite a few respected asset managers go to great lengths to produce forward-looking estimates for financial assets – and most of these suggest that equities might still be a half decent bet. Some, such as GMO, tend to err on the side of considerable caution. Others such as those from Robeco – another respected house with a strong quant bias – err more towards a middle of the road view. A few weeks ago, they brought out their 2019-2023 estimates, with the headline that ‘patience is a virtue’, which is probably a sensible forecast. And what do they think will happen to asset class returns: see the table below for the hard numbers. Their message: most bond investors will struggle, look to emerging markets and commodities for upside. I think Robeco is probably about right when it comes to emerging markets and the pitfalls of fixed income securities but I’d be much more pessimistic about developed world equities. I’d be guiding down towards a per cent or two a year.
|Expected annual returns 2019-2023*|
|Developed market equities||4.00%|
|Emerging market equities||4.50%|
|German government bonds||-1.25%|
|Developed global government bonds||-0.25%|
|Emerging government debt (local)||3.75%|
|Investment grade credits||1.00%|
|Listed real estate||3.25%|