Twice Bitten Forever Shy
Rowan Dartington Signature’s managing director Guy Stephens comments on equity markets and the major events currently influencing investors’ behaviour.
The markets are currently heavily influenced by all things political and have been since the early summer. This is making valuations increasingly difficult to assess as distortions abound involving currencies, elections, interest rates and quantitative easing. These are all macro-economic measures which are pushing markets around causing investors confusion.
Taking the UK on its own, the weakness in Sterling has pushed the FTSE-100 to new highs based on the currency translation and perhaps a perception that the immediate impact of Brexit is not going to be as bad as feared. However, we now seem to have moved into a negative correlation situation. As the value of Sterling weakens, the higher the FTSE-100 goes! Our new political leaders appear to have adopted a stance of talking up the impact of Brexit, probably so they can report a result that is better than feared when the next election comes around. Some overseas earning businesses are looking expensive and trading on price/earnings ratios of 25 times when there has been no improvement in their operating performance. But does this actually mean valuations are expensive and due a fall or are we missing the bigger picture.
One often quoted reference point is the historic high of the FTSE-100. This falls into a common investor mistake known as ‘anchoring’. This is where a psychological benchmark assumes a disproportionate influence in the investor psyche as it has previously spelled doom. This is especially pertinent of the level of 7,000 on the FTSE-100 although there is no logical reason for it to have an influence at all – it is just a number, albeit a round one that has never been meaningfully breached in the past without a significant sell-off following. This is actually pure coincidence because on a total return basis, with dividends reinvested, the FTSE-100 is over 80% ahead of the level reached at the end of the Millennium.
Not so in the US, where the S&P 500, in capital-only terms, broke into new territory in January 2013 and has since risen by a further 85% on the same basis, or 96% on a total return basis. The general perception is, however, that equity returns have been modest, largely because many investors have been investing cautiously, perpetually looking for the next bubble having missed the biggest two in the last twenty years, being the dotcom bubble of 1999 and the credit bubble of 2008.
Given that the equity market is one of the few mainstream asset classes that currently provides any prospect of forecastable positive return (and yield), it is perhaps surprising that it isn’t more expensive than it currently is. For those requiring some solace, I did see a calculation of the cyclically adjusted price earnings ratio this week which declared that it was below the long run average and that UK equity markets were not actually expensive. However, the same could not be said of the US equity market which was looking expensive on this measure but also on others such as price to book, which is a popular accounting measure of valuation.
We keep looking at this in our monthly asset allocation meetings as the markets advance and we continue to debate market levels in all asset classes. There are many investors who cashed out ahead of the Brexit vote and have now foregone returns of over 12% on the FTSE-100 or over 21% on the S&P 500. These same investors are also likely to remain in cash ahead of the US election as that is seen as another catalyst for weakness. They will also be expounding a bearish view to support their position which is looking more wrong as each day goes by. To invest today and believe the pollsters with regard to Hillary Clinton being returned when the Brexit polls were so wrong, would appear very speculative and foolhardy to most.
Focusing more on fundamentals, Alcoa reported disappointing results this week, opening up the third quarter reporting season for the US. Employment payrolls were lacklustre on Friday, neither suggesting a rate rise was more likely nor the opposite. Whilst UK politicians continue to talk of a ‘hard’ Brexit, Sterling will remain under pressure and this looks likely until at least we trigger Article 50. No matter how sanguine you may be regarding Brexit, from March next year, the UK is on a collision course with the EU. Free trade will be positioned against free immigration with the price tag of £350m a week at stake (to quote the Brexiteer’s disputed number). The EU needs our contribution so what price for a compromise?
With regard to the US election pollsters, if ever the phrase Once Bitten Twice Shy were appropriate this would be it when comparing to the Brexit polls. With regard to the wider UK equity market, it appears like Twice Bitten Forever Shy as we break new ground.
Guy Stephens, managing director at Rowan Dartington Signature