Is the bull market long in the tooth?

The current global economic expansion or cycle has been going for just over nine years since the global financial crisis. Equities keep on rising and seem to shake off bad news. It is the second longest bull market in US history since records began in 1850. Next year it will become the longest. So is it long in the tooth as some believe or is it the case that bull markets don’t die of old age as other investment professionals have opined? Certainly it is a market that keeps on giving. Some of the best performing funds in the first half of 2018 were US equity funds and US heavy global technology funds. In contrast emerging markets performed poorly. I remember about three years ago asset allocators and fund managers were suggesting the US equity market was fully valued and they shifted money out of the US to Europe and the UK where valuations were more attractive. They clearly underestimated the strength of the US economy, the ability of US companies to continue grow their earnings and the potential for equity prices to carrying on rising. Fortunately I never bought into that argument.

So what is going on? According to Iain Stewart lead manager the Newton Real Return fund QE has been the greatest monetary policy experiment the world has ever seen. It was designed to inflate asset prices and it has achieved that. Investors have become conditioned to expect further central bank support every time there is a problem – remember for example Mr Draghi’s promise to do whatever it takes. Moreover this expansion has been characterised by low growth, the real economy has hardly recovered, so investors have had little fear of the economy overheating and interest rate rises. So they feel the outlook remains good and carry on investing. In contrast Stewart says there is now a broad based bubble in asset prices. He argues that the previous two bubbles were quite narrowly focused – the one in the late 1999s was on technology and second on banking and US real estate. This time cheap money from the developed world has spread around the world inflating all asset classes. Stewart refers to this as the financialisation of economies.

Stewart thinks it is tempting to think that if the authorities can extend the cycle this long, why not indefinitely? Such a thesis would suggest the end of boom and bust but don’t however ask for Gordon Brown’s opinion on that! Stewart is concerned about the tremendous amount of debt which has increased by 40% since the financial crisis, not so much by households but governments and corporates. This is hardly surprising with very low interest rates and plenty of cheap money.

He also highlights issues arising out of new regulations on banks and market participants since 2008 with concerns about liquidity in both the bond and ETF market and increased volatility. ETFs, exchange traded funds are traded securities that passively track stock market indices. There has been massive inflows into ETFs in recent years driven by very low charges compared to actively managed funds and the belief that stock pickers can’t beat the market. Richard Buxton of Old Mutual Global Investors, a highly respected UK fund managers is concerned about the “dumb” money flowing into ETFs. It means large amounts of cash is being pumped into mega-companies who have high weightings in indices that ETF track pushing up their share prices for reasons that are unrelated to fundamentals.

Suzanne Hutchins, a co-manager of the Newton Real Return argues that because there is earnings momentum it does not mean that equities market can’t fall. She observes that in the last 13 bear markets there have been three common threads, strong earnings growth, very elevated valuations and no volatility or very little. Spot the similarities with today’s markets! It is evident Stewart and Hutchins do not subscribe to the view that boom and bust has died and they see plenty of risk. Hutchins quotes data from Professor Schiller that suggests the average bull market has been around 131% whilst this one is well over 300%. Moreover investors have been benefiting from 18% to 20% p.a. returns from equities whereas in the very long term the real returns (i.e. after inflation) have been closer to 5% to 6%. There is plenty of scope for a sell-off and bear market.

So what do I conclude? I find these views compelling and remain cautious although not ultra-cautious. I see no need to sell all and buy cash but to position portfolios defensively investing in funds that focus on preserving capital or limiting volatility. The minimum goal however for any investor is to beat cash and inflation.

The content of this blog is intended for general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.